Oil rout squeezes borrowers in energy regions

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More than $1 trillion in U.S. real estate debt from the last decade’s property boom is starting to come due as oil prices stagnate, squeezing property owners in cities and towns centered around the energy business.

The 50 percent plunge in crude values since June is already dragging down property prices in Texas, according to Green Street Advisors LLC. Real estate investors are adjusting their underwriting across the state as they gird for contraction at energy companies, demanding higher yields on their investments, the property-research firm said.

“It is going to be harder and more costly for borrowers in energy hubs to refinance loans in today’s environment, versus when oil was $100 a barrel,” Andy McCulloch, an analyst at Newport Beach, California-based Green Street, said in an email. “Just how much harder or costly will depend.”

Even as U.S. commercial real estate values surge past records set in 2007, with cash from around the globe pouring into the best buildings in the biggest cities, lenders are becoming more cautious in regions that rely heavily on the oil industry for growth. That could create higher hurdles for borrowers that need to refinance mortgages in places such as Texas and North Dakota, according to Andrea Bryan, a managing director at New York-based financial-services consulting firm NewOak Capital LLC.

Lenders are reassessing risks in energy towns as roughly $1.1 trillion of property loans come due across the U.S. over the next three years, according to Richard Hill, a real estate debt analyst at Morgan Stanley. About $345 billion is left over from a lending binge on Wall Street that culminated in 2007 with a record $232 billion in sales of securities linked to properties including skyscrapers, shopping malls, hotels and apartment buildings.

Houston tower

One such property is One City Centre, a 31-story office tower in Houston. Almost a third of the building is occupied by energy-service firms, including Energy XXI Ltd., a decade-old oil acquisition and production company, according to data compiled by Bloomberg.

The owner of the building, Accesso Partners LLC, recently refinanced $70 million in debt that was due in August. The lender, JPMorgan Chase & Co., demanded additional cash be set aside to mitigate risks associated with the building’s energy tenants, according to Mike Adams, who manages assets in Texas for the Hallandale, Florida-based company.

“It was a little more difficult than we were expecting,” Adams said in a telephone interview.

Houston, home to more oil companies than any city in the world, was the nexus of the energy crisis in the 1980s, when seven of the 10 largest banks in Texas failed. Soured commercial real estate debt was the biggest driver of losses, according to Standard & Poor’s.

Less concentration

Debt on commercial properties is less concentrated within the regional banking system than in the ’80s, according to Bryan of NewOak, meaning any losses shouldn’t fall as heavily on those institutions. In the years leading up to the 2008 real estate crash, lending to property owners by Wall Street firms such as Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. climbed.

Still, local lending to real estate developers and landlords never went away, according to David Bishop, a bank analyst at Drexel Hamilton LLC.

“Commercial real estate is a big piece of the puzzle for regional and community banks,” Bishop said in a telephone interview. “Banks I follow in Texas are keeping an eye on office rentals and multifamily for any spillover” from the plunge in oil prices.

Scaling back

Banks have yet to report significant issues related to oil prices, Bishop said. If they do, the companies are likely to rein in real estate lending and impose more onerous terms on landlords who are refinancing, he said.

At one Texas lender, cutbacks in property lending were planned even before oil began its slide, following several years of fast growth. Texas Capital Bancshares Inc., the state’s ninth-largest bank by assets, began mapping a retrenchment in its commercial real estate and builder-finance businesses in July, Chief Executive Officer Keith Cargill said in a presentation for investors last month.

“We don’t feel comfortable sustaining that pace of growth, even though it’s available for the next year or two, because of concentration risk,” Cargill said in the presentation. “It’s real estate that presents the biggest problems if you have a concentration” during a recession.

‘More aggressive’

The Dallas-based lender is “remaining disciplined with our credit underwriting standards,” Cargill said in an e-mail this week. “The commercial real estate market in Texas has become more aggressive than we have been in the past two years.”

The economy is more diverse in cities including Dallas and Houston than it was in the ’80s, mitigating the risks for properties in those areas, according to Bryan of NewOak. Borrowers also will benefit from the global search for yield as investors move into riskier corners of the real estate market to get higher returns, she said.

Properties in smaller cities such as those that grew around North Dakota’s Bakken shale are at greater risk of defaulting on loans than those in major metropolitan areas, according to Lea Overby and Steve Romasko, analysts at Nomura Holdings Inc.

As long as uncertainty over the direction of oil prices clouds the outlook for local economies that benefited from the run-up, landlords in parts of the U.S. will probably face tighter credit, the Nomura analysts wrote in a January report. Outside Texas, borrowers in cities such as Denver, Pittsburgh and New Orleans may also feel the pinch as lenders pull back, they said.

“Everybody knows that the oil market is declining right now, but they don’t know where the bottom is,” Bryan said. “There may be loans that are performing well, but the cost of financing is still going to be higher.”