It’s tempting to believe the map. To run your finger over the blue swath of the Pacific and imagine that these are islands. But the turmoil in the world’s financial markets has demonstrated that Hawaii’s isolation is an illusion.
Our economy — particularly capital-intensive sectors like real estate development and construction — has become dependent on access to money from the Mainland and abroad. And the long string of failures in the financial community — Washington Mutual, IndyMac, Bear Stearns, Lehman Brothers — has cut deeply into the availability of that capital.
Some failures have affected Hawaii directly: The Ritz-Carlton development at Kapalua was nearly derailed when Lehman Brothers, the lead bank, went bankrupt last year. Similarly, the credit problems of General Growth Properties have halted construction at its Ward Villages project in Kakaako. But more damaging has been the complete collapse of the market for the Commercial Mortgage-Backed Securities and other financial instruments that have been the conduit for most of the Mainland capital underpinning development in Hawaii over the past six years.
The Return to Local
“Sixty percent of all loans were through the CMBS market,” says Mike Hamasu, director of consulting and research at Colliers Monroe Friedlander.
“The majority of that is now frozen.”
The result has been an exodus of Mainland lenders — with boggling effect. “I can give you our preliminary findings for last year,” Hamasu says. “In 2007, total sales for the state came to $3 billion. Our prediction for 2008 is $780 million,” an astonishing 74 percent drop. This year will be even lower: “We’re anticipating sales of only $580 million in 2009,” he notes.
One of the signature effects has been the emerging dominance of local banks. Central Pacific Bank, for example, came forward to replace Lehman Brothers as the lead bank in the Ritz-Carlton development on Maui. Most developers indicate that deals will now have to include local banks. The change is not an idle one; Hawaii’s local banks have a reputation for conservative underwriting. For developers, this means much higher equity requirements; no non-recourse loans; and, critically, higher presale and prelease requirements before the borrower can access construction loans. All of which are more difficult in a recession.
Presales Are Crucial
For Allen Leong, director of operations for KC Rainbow Development Co., the crisis in the world capital markets is neatly bracketed by two projects along Kapiolani Boulevard: the twin towers of Moana Pacific, completed in early 2007, and the Moana Vista, started in 2007 but still unfinished and awaiting new capital.
“The issue with Moana Vista is the basic issue of every single real estate project: presales,” he says. “At the Moana Pacific, the first tower sold out within six months. The second tower might have taken nine or 10 months to sell out.” Presales of the 492-unit Moana Vista began in 2007, amid much the same atmosphere of optimism and enthusiasm. Hundreds of people showed up when units first went up for auction. “At one point in time,” Leong says, “I had 300 units sold.” But the stream of bad economic news sapped the confidence of buyers, and more than half canceled their contracts.
Only deep pockets kept the project afloat. Indeed, one of the remarkable things about the Moana Vista project is that the work so far has been done out of KC Rainbow’s cash flow. “You have to remember, I just came off a pretty successful project,” Leong says, alluding to the highly profitable Moana Pacific project. “But now, we’re going to have to touch our loan. That’s why presales are so important. Without presales, you can’t touch that construction money.” It’s this gap in funding that has brought construction nearly to a standstill.
Of course, in real estate, it’s possible to view almost any problem as a question of price. In December, KC Rainbow began slashing prices at Moana Vista, with units going for as much as 25 percent off. “I can tell you,” says Leong, “right now, we’re at the right price point. We’ve had very good interest in the project. People like what they see. so, I know there are buyers out there who like the price. I just don’t know how many there are.”
The Contractor’s Perspective
Bill Wilson, president of Hawaiian Dredging, also views Hawaii development through the lens of the current credit crunch. “We’ve got four stories with projects that Dredging is working on, with four sets of issues,” Wilson says. “Others, I’m not sure, have similar examples.
“No. 1 is Maluaka on Maui.” This luxury condominium project – plans included 69 high-end units on 500 acres of land attached to the Kapalua Resort – came out of a partnership that included Dowling Development and investment banker Morgan Stanley. Construction never started. “They put the financing together a year and a half ago,” Wilson says, noting that, at the time, “there were still multiple financing options available.” One by one, though, lenders dropped out as the capital markets collapsed. “They’re not looking at revised development plans,” he says, but the project is moribund.
Hawaiian Dredging’s second story concerns Starwood’s latest planned timeshare on Maui. “In this case, we were two months into construction,” Wilson says. “That was a $300 million job. It was their preferred job in Hawaii.” Nevertheless, despite their investment of time and money, Starwood blanched at pursuing the project in this economic climatem, pulling the plug on construction. “We negotiated a scope-of-work so that it could be put on hold,” Wilson says. “Conceivably, we can start the project again in a year or two.”
Hawaiian Dredging is also the contractor on KC Rainbow’s Moana Vista project, which is Wilson’s third story. In this case, of course, the company was already deeply committed to a project that appeared to be more than adequetly funded. The building was scheduled to be completed by 2009; instead, the tower crate sits idle, and the most optimistic finish date is well into 2011.
“No.4 is General Growth,” says Wilson. “We filed a lien of $9 million against them.” The credit troubles of General Growth Properties, the nation’s second largest developer of shopping centers, and the owner of both Ala Moana and Ward shopping centers, have received a great deal of publicity. Although generally regarded as well-managed, the company has succumbed to the credit crisis. Its inability to refinance its extensive debt has put the company on the brink of failure. The spectre of bankruptcy has halted construction at Ward Villages, General Growth’s most recent development in Kakaako. Once again, Hawaiian Dredging is left holding the bag. “All I want is our little $9 million,” Wilson says. “And the majority of it doesn’t belong to us; it belongs to our sub-contractors.”
Other contractors have a similar view of the market. Roger Peters, the new executive vice president at dck pacific construction (formerly Dick Pacific), says, “I know of five out of about 15 projects that we’re tracking that have stalled because of lack of funding. And that’s not just on Oahu; that’s on Maui and the Big Island and Kauai.” In fact, one of the most alarming aspects of the capital shortage for developers is that it touches almost every sector: residential, commercial, industrial and retail.
Light at the End of the Tunnel?
One bright spot on the horizon is Halekauwila Place, an affordable-housing project in Kakaako being developed by Stanford Carr. This project, like so many others around the state, stalled due to inadequate funding. The details are telling: Although Carr was able to secure a $71 million construction loan from the National Electrical Benefit Fund, that still left him well short of the estimated $86 million price tag for the project. Normally, Carr points out, affordable housing is supported with tax credits, which the developer sells to investors. In the current market, though, there’s no appetite for tax credits. The project looked untenable.
But Halekauwila Place was very attractive to the Hawaii Community Development Authority. As Anthony Ching, executive director of the authority, points out, HCDA was eager to add the affordable housing units to the inventory in Kakaako. They also hoped to retire the tax credits so they couldn’t be sold to another developer. In the end, HCDA agreed to loan the developer $14 million. Perhaps just as important, the terms of the loan allows $4.5 million of that to be used for the critical permitting and entitlement period. “Essentially, the state is providing a soft second mortgage,” says Carr.
Affordable housing is hardly a salvation for developers, though. The margins are just too low, and few government agencies have the cash to lend. Instead, most developers and contractors look at the capital markets and see no near-term solution. They point to Kapolei: The plat map shows a quilt-work of projects in various stages of planning and construction. But most developers agree with the words of Stanford Carr: “If it hasn’t come out of the ground, it’s probably on hold.”