Real Estate Update : Real Estate Blamed for Phoenix’s Financial Woes : Arizona: High commercial vacancies, land speculation, bankruptcies and foreclosures deal heavy blow to capital’s economy.
Color it yellow for the bright desert sun, add a touch of brown for the rich earthen tones of real estate. What do you have on the color wheel? A light, pleasant brown?
For this “Cinderella” city of the postwar Southwest, unfortunately, the mixture has emerged as plain, unadulterated mud.
While much of the negative publicity that Phoenix has received since its bubble burst in 1987 has centered on its collapsing financial institutions, the major villain lurking in the background has been the real estate market.
For more than 30 years real estate has been the sword that Phoenix lived by and, occasionally, died by.
Maricopa County, of which Phoenix is the hub, has ballooned from 106,000 residents in 1950 to 2 million today, and has attracted such high-tech manufacturers as Itel, Motorola and McDonnell Douglas Helicopters. And such Fortune 500 companies as Greyhound and Phelps Dodge have chosen to move their corporate headquarters here.
The principal lure? Cheap and endless real estate, and outside investors willing to pour billions into ventures that in colder, more conservative climes, would have been considered wildly speculative.
In-state financial institutions--for the most part captained by Arizona natives who prided themselves on sealing multimillion-dollar deals with a handshake--were in the wings, willing to take up any slack.
The gung-ho, shoot-from-the-hip style has never been without its downside risks though.
“After extraordinary growth in the early 1960s, everything went sour and we had record vacancies--as many as 20% of the apartment developments in some areas,” said Jay G. Butler, director of Arizona State University’s Real Estate Center.
“We had most of the elements then that we have now--in particular, a lot of land speculation. John Long (a pioneer Phoenix home builder who, since the 1950s has constructed an estimated 35,000 homes in the area) had 1,000 unsold homes sitting out there at one time.”
And in both 1975 and 1982, Butler said, similar booms and busts occurred. “They were very sharp on both the downside and the upside--V-shaped. This current decline may still have a way to go on the downside, and the pull-out may be slower.”
With such a boom-bust history, what happened in the mid-1980s that caused Phoenix developers and investors to embark on the speculative frenzy leading to today’s problems?
Problems which, almost two years after the collapse, still haunt Phoenix: vacancies in industrial real estate hovering at 22.7%--from a low of 10.4% in distribution space to as high as 45% in high-tech research and development real estate--and vacancies of about 17% in apartments and 27% in office space, according to Don Morrow, senior marketing consultant for the Phoenix office of Grubb & Ellis.
Fogging memories of past busts, local experts say, was a sudden, explosive growth in the area that even by bigger-than-life Phoenix standards, was extraordinary: besides the nation-leading 8.2% in job growth in ‘85, construction employment alone soared 74.5% between 1982 and 1986.
Also, new and even more aggressive players were entering the ballgame, as personified by Charles H. Keating Jr.
Through his Phoenix-based American Continental Corp., which he converted from a traditional home construction company into a high-flying financial-services company, Keating, in 1984, used the local company to buy Irvine-based Lincoln Savings & Loan Assn.
And immediately he began using Lincoln’s federally insured deposits for everything from land speculation and real estate to junk bonds, LBO financings and futures speculation, federal regulators say.
In all, regulators say, Lincoln provided about 90% of American’s assets and revenues until the S&L; was seized and put under the Resolution Trust Corp. umbrella in April, 1988.
And, of the estimated $2 billion that taxpayers stand to lose on the Lincoln Savings deal, about $1 billion of it is in land acquisitions, development and construction loans, and another $900 million is in indirect real estate investments in the form of raw land acquired for development and speculation.
Where? In the already hurting Phoenix real estate market.
Keating’s most ambitious project was the grandiose Estrella master-planned community in the desert, about 45 miles southwest of downtown Phoenix--a 20,000-acre tract that was to house a community of 200,000 residents, several golf courses, an office park, a 400-room resort hotel, schools, shopping malls and a hospital.
The up-front money for sweeping, four-lane roads lined with palm trees, a bridge over a desert wash, grades, street lights, a community center and two lakes encompassing 75 acres was estimated, conservatively, local real estate observers say, at $70 million.
Estrella, today under the control of the RTC, is a pleasant, but lonely drive into the quiet desert.
Similarly hung out to dry are the vast holdings of Burns International Inc., headed up by 36-year-old Robert Burns, an aggressive Phoenix developer. His most ambitious project, Sun Valley, bears a striking resemblance to Keating’s Estrella development.
Sun Valley is about 45 miles west of downtown Phoenix, and is a 28,000-acre master-planned community of which Burns owns or controls 23,100 acres, and 95 other property owners control the balance.
Fifty of the 95, including Burns, filed Chapter 11 bankruptcy reorganization petitions in early February to protect their land from reverting to Heron International of London, Burns’ financial partner in the venture.
Heron had guaranteed $82 million in bonds that the landowners used to finance Sun Valley Parkway, a four-lane, 30-mile road that connects with Interstate 10 on the south and sweeps grandly through what was to be the heart of the planned-community.
A highway sign at the eastern junction of Interstate 10 and the lonely Sun Valley Parkway says it all: “No Services Next 35 Miles.”
Despite the current collapse of the real estate market, experts here are reluctant to lump Phoenix in with Dallas, Houston and Denver--cities with similar problems.
“Both Dallas and Houston have more vacant office space than Phoenix has total office space,” said Don Morrow, senior marketing consultant for the Phoenix office of Grubb & Ellis.
“In 1989, we absorbed about 1.8 million square feet of office space. That’s an absorption rate of more than 5% and in the same period, Los Angeles absorbed about 6% of its space. If we return to the same growth that we had before this happened, about 4%--which isn’t an unreasonable target--that vacancy factor will be cut in half in two years.”
Still, there are disturbing blobs of real estate fat around Phoenix’s midriff that seem to defy current belt-tightening efforts.
An example, according to Ralph E. Kammrath, a real estate consultant here, is in shopping center construction, which is booming along with 8 million square feet of new space in the works--50% more than was under construction a year earlier and five times the space that Kammrath estimates is needed in a single year to satisfy normal demands.
The current vacancy rate for retail space, he said, is about 16.19%, rising to 18.45% by this October and to 20.13% by October, 1991.
Also showing no abatement, according to Ralph Shattuck, publisher of Foreclosure Update Newsletter, are real estate properties being reclaimed by lenders.
“Last year,” he said, “foreclosures in Maricopa County totaled $4.4 billion--up from $3.3 billion in 1988. About $1 billion of last year’s foreclosures were on residential property, the rest was commercial. And in January of this year, an additional $439 million in foreclosures were exercised, with about $104 million of that in residential.”
Under normal circumstances--such as pre-bust 1985 and 1986--Shattuck added, Phoenix averages 600 to 700 residential foreclosures a month. “And we’re seeing more than twice that at the present. And commercial, of course, is an entirely different world--five years ago we were seeing maybe $50 million a month in foreclosures. Now look at January with about $335 million in foreclosures.”
The foreclosure figures notwithstanding, both Shattuck and R. L. Brown of Home Builders Marketing Inc., another Phoenix real estate research firm, agree that the single-family home situation here is considerably brighter than it looks on the surface.
“We’ve got about 600,000 single-family homes here and the lenders are holding about 2,500 to 3,500 of them, FHA has another 3,000 and HUD has fewer than 1,000,” Shattuck said.
“That’s not all that many houses sitting empty because of foreclosure. And, (in January) we had 873 new homes sold and 2,329 resales--that’s about 12,000 sales a quarter, which gives us about a three-month surplus. Which, all things considered, isn’t all that bad.”
And Brown added:
“There’s been very, very little serious price-cutting here in the residential market, except in older, run-down houses and in the condo market. Condos died out here back in 1981 and 1982--long before these troubles hit us.”
The current slump, he said, has reduced the number of new houses coming on the market to 12,311 in 1989 and a projected 13,500 this year from the normal, non-boom average of 15,000 to 17,000.
The number of home builders has also dwindled from about 73 putting up 50 or more homes a year in 1986 to about 46 today, he said.
“We’re expecting a gradual increase in new housing to about 18,000 to 18,500 a year by the mid-’90s,” Brown said, “but we certainly don’t expect anything near the record 22,000 that were built at the peak in ’86. That was a real aberration.”
One of the bright spots that Phoenix real estate experts see in the area’s present slump is that the opportunities are attracting outside investors.
“Especially Californians,” Grubb & Ellis’ Morrow said. “It’s frequently quicker to get from Phoenix to Los Angeles (by air) than it is to get from one end of L.A. County to the other.”
With this distribution-hub advantage as its teaser, Grubb & Ellis, in the final months of 1989, took a three-hour film presentation on the road to capacity audiences in Orange County, Los Angeles and San Francisco. By the end of the year, it had chalked up $36.5 million in commercial sales to Californians.
“In the South Los Angeles basin area,” Morrow said, “a developer is looking for distribution buildings with a replacement cost of $55 to $65 a foot and returns of 7 1/2% to 8 1/2%. We’ve just placed three sales in escrow here at costs under $25 a foot and returns of 9 3/4%.
Apartment units, according to the most recent study by researcher Kammrath, have dropped in price to the lowest level in the last decade--to $24,068 a unit in 1989, an 18.5% plunge from the decade high of $29,517 in 1984.
And in the office building market, the RTC announced in February the sale of the Biltmore Commerce Center on Camelback Road to Shurl Curci, chairman of the Transpacific Development Co. of Torrance, for $26 million. The 250,000-square-foot structure was built for $35 million five years ago and was listed by the RTC late last year at $29 million.
Assuming a return to more reasonable growth rates of 4% to 5% in Phoenix, ASU’s real estate expert Butler said the area should be much improved within two to three years (the optimistic assessment) to five years (the pessimistic).
The one exception: raw land around the periphery of Phoenix, which, developers and bankers agree, will remain a drag for years to come. Some acreage, flipped up to $90,000 an acre, is now listed at $25,000, with no takers.
