🔒Commercial lending activity has slowed in CT; will the pace pick up in 2024? Stalled projects will depend on it

Over the past two years, developer Amit Lakhotia has invested $5.5 million to convert the former five-story, roughly 125,000-square-foot former Stanley Black & Decker headquarters on Myrtle Street in New Britain into 115 apartments.

During that time, the project’s estimated budget has jumped from $7.5 million to $15 million due to inflation, an increase in the number of planned units and unexpectedly high costs to move through the state’s environmental certification process, Lakhotia said.

Lakhotia is now looking for $10 million in capital to complete the project before the end of this year and begin renting in early 2025. But the search has been difficult.

One bank would only lend about half the money Lakhotia is seeking. Talks are ongoing with another bank. If that doesn’t pan out, Lakhotia said he could turn to a private equity lender — with rates of up to 14% — to complete the project.

“It’s tough and getting tougher,” Lakhotia said of the borrowing climate.

Access to capital for commercial borrowers in Connecticut tightened up significantly in 2023, as evidenced by a slowdown in the growth of new loans. Bankers and developers attribute that to a mix of economic uncertainty and high interest rates and construction costs.

Predictions vary, but some expect activity to pick up in 2024, as economic conditions stabilize.

2023 slowdown

The pace of lending for construction and/or the purchase of retail, warehouse, office and other commercial properties among 27 banks headquartered in Connecticut — excluding Webster Bank — rose by hundreds-of-millions of dollars in 2020, and again in 2021, and then surged by 18%, or $1.29 billion, in 2022, according to Federal Deposit Insurance Corp. data compiled by the Hartford-based Bank Analysis Center.

Last year, however, bankers and borrowers took their foot off the gas, and the amount of commercial loans held by Connecticut banks increased by a far more meager $282 million, or 3%.

The Bank Analysis Center excluded Webster Bank from the analysis because its merger with New York-based Sterling Bank would significantly skew yearly comparisons.

“(Banks) have stiffened up,” said Bank Analysis Center President John Carusone. “It went from 18% to 3% (growth). It went down by a billion dollars.”

The amount of loans held by Connecticut banks for multifamily assets grew 2% in 2020, 9% in 2021, then soared 37% in 2022, before moderating to 16% last year, according to the Bank Analysis Center report.

Carusone said most banks have built up “fortress” balance sheets with deep reserves against potential commercial real estate losses, which reduces their ability to lend. Banks are also concentrating limited lending capital on long-standing customers that offer more than just a one-time borrowing opportunity.

“In general, it’s clear the industry has become much more circumspect about lending commercial real estate and multifamily loans in anticipation of what the future holds, both in terms of the economic outlook and the level of discipline the Federal Reserve is going to exercise with regard to inflation,” Carusone said.

‘Greater public subsidies’

This March, Lexington Partners struck a deal with the town of East Hartford to build a minimum of 150 apartments in the first phase of a larger redevelopment of the Founders Plaza office park along the Connecticut River. In return, the town signed off on the use of $6.5 million in state grant funding to demolish an empty office building at 20 Hartland St., to make way for the multifamily building.

Lexington Partners President Christopher Reilly said his Hartford-based development firm and other partners in the “Port Eastside” redevelopment still hope to build closer to 300 units in their first building, but they don’t want to overpromise, given lenders’ ongoing reluctance and high construction costs.

Port Eastside also sought and received additional flexibility with the project’s timing. A first draft of a town agreement required the initial building to be completed within four years; a revised final agreement requires that Port Eastside secure a building permit within four years.

If it doesn’t meet the deadline, the $6.5 million state grant will turn into a loan.

“We have to be careful now, the capital markets are a little bit crazy,” Reilly recently told East Hartford Town Council members. “We don’t want to overcommit. There’s going to be somewhere between that 150 units and 300 units that is going to be financeable, and is going to make sense.”

Michael Freimuth, executive director of the Capital Region Development Authority, said banks have reduced the percentage of a project they’re willing to finance, prompting developers to look to his economic development agency to cover widening financing gaps.

“Banks had been going 60% to 65% loan-to-value,” Freimuth said. “They are probably down around 50% now. That’s 10% to 15% less mortgage you can get now. …It’s requiring greater and greater public subsidies to make deals work. That’s before factoring in recent increases in construction costs.”

In the past decade, CRDA, a quasi-public state agency, has been the key to incentivizing developers to build thousands of market-rate apartments in downtown Hartford, a key economic development strategy for the city. Low interest loans from the agency have closed funding gaps.

CRDA participation also automatically triggers a lower tax rate for multifamily developments.

CRDA’s loan terms had been inching down to around 20-year repayment periods, but that has shot back up to 30- and 40-year repayment schedules due to higher interest rates and other rising project costs, Freimuth said.

“That’s just to make the numbers work,” he said.

Randy Salvatore, one of the busiest and most-seasoned developers in Connecticut, said he’s feeling the pinch from higher interest rates, but can still get financing because of his many years of experience.

In December, Salvatore broke ground on the second phase of his North Crossing development in Hartford, which will add a roughly 500-space parking garage and 237 apartments on a 5-acre lot across the street from Dunkin’ Park. He’s also preparing to demolish buildings on the nearby Rensselaer Polytechnic Institute campus, ahead of a massive, mixed-use redevelopment of that 12.7-acre property.

“It’s definitely gotten more difficult in general,” Salvatore said of the lending environment. “Banks are only lending to people with a strong track record and who they have a strong relationship with. Even with all that, it’s a lot more difficult.”

Salvatore said he senses some easing in the lending climate since the turn of the year, and expects interest rates to tick down in 2024.

“(Banks) were out of the market, and now they are coming back,” Salvatore said. “They are treading slowly, but they are coming back.”

Discerning lenders

Jayne Kelly, executive vice president and chief commercial banking officer at Naugatuck-based Ion Bank, said higher interest rates have pushed some projects outside underwriting boundaries. But it’s not only banking standards slowing lending activity, she noted.

Higher construction costs have also prompted some developers to pause projects, she said.

“Certain projects that last year would have underwritten and cash-flowed are not showing that same degree of comfort,” Kelly said.

Kelly said Ion, which has $2.2 billion in assets, is wary of financing office building deals, but is also cautious about overexposure to multifamily assets.

Last year, Ion lent $325 million to businesses and for commercial real estate development and investment, Kelly said. This year, the bank has set a lending goal of $250 million.

“We are remaining active, but on a selective basis,” Kelly said.

Despite an abundance of caution from borrowers and lenders, Kelly said demand has been brisk this year. Ion closed about $45 million in commercial loans through February, and has another $100 million under consideration.

“There is still a good amount of activity,” Kelly said. “We are still seeing brisk lending opportunities.”

Jeremy Miller Sr., executive vice president and chief lending officer for Liberty Bank, said commercial lending activity at his Middletown-based bank in 2023 was 90% of what it had been the prior year.

“On the commercial real estate front, there is a lot of opportunity, but I think it’s selective opportunity,” said Miller, whose bank has $7.7 billion in assets.

Miller said the current high yield on certificates of deposit (around 5%) is giving real estate investors a place to park cash with a solid return, prompting some to wait for better commercial real estate conditions.

NBT Bank Regional President Andreas Kapetanopoulos said the volume of commercial loans his institution produced in Connecticut dropped significantly at the start of 2023, but made a strong recovery late in the year, putting production on par with 2022.

And this year is looking even better for New York-based NBT, which has $13.2 billion in assets.

“What we are seeing is projects we started discussions on two years ago, they are actually coming back to us now, and certain sponsors and developers are saying now is the time,” Kapetanopoulos said.

Kapetanopoulos said NBT’s commercial lending is split between 60% real estate and 40% commercial and industrial loans. Multifamily makes up the largest share of commercial real estate loans, he said.

With interest rates likely to decrease at some point this year, and with construction costs moderating, developers are feeling confident enough to push forward with dormant projects, Kapetanopoulos said.

“The rates are higher, but costs have stabilized,” Kapetanopoulos said. “They have readjusted their budgets, maybe readjusted the scale of their project as well.”

Kapetanopoulos and other bankers said developers typically need to put in additional equity to make projects work.

Often, a portion of financing is coming from state subsidies for workforce or affordable housing through the Connecticut Housing Finance Authority, Kapetanopoulos said.

“The thing that helped clear things up is that rates are high but at least we have stabilized now,” Kapetanopoulos said. “We are not in the increasing-rates mode … . That clarity makes it easier on the budgeting side. Now, people can go back and right-size their projects. It’s easier to plan.”