Constricted Credit Still Putting the Squeeze on Architecture Firms
After moving beyond last fall’s credit crash, banks are finding more reasons not to lend

by Zach Mortice
Associate Editor

How do you . . . understand the current crisis and a way to ride it out.

Summary: With clients unable to secure credit for projects—from high-end residential to commercial developers—three architects describe how they are coping as they wait for the light at the end of the tunnel.

In the wake of the economic crash that brought credit markets to a screeching halt last September, Ana Escalante, AIA, saw the ripples soon enough. Her clients, who were developing an $80 million mixed-use condo project called South Palm Canyon in Palm Springs, Calif., were being weaned off the credit they needed to make the deal. Escalante Architects’ 225 townhouse, apartment, and studio condos, complete with retail tenants, were supposed to breathe new life into Palm Springs’ downtown core. It was also the largest project she had ever taken on. As banks denied South Palm Canyon LLC credit, the owners Brian Linnekens, Robert Herscu, and Robert Ozell became reluctant to shoulder all the costs themselves, slowly sending the project into hibernation.

First the landscape architects were told to hold off on the project. Then the structural engineers. Then the sustainability consultants. “One by one, they were put on hold,” Escalante says. “It was gradual. We were the last ones left.”

The project was finally shelved in November, amid a faltering Southern California residential building market that was leaving entire new neighborhoods abandoned. But she’s maintained a good relationship with South Palm Canyon’s developers and still hopes the project can get moving again someday. At least as importantly, she still got paid for the work she had done. She hasn’t always been so lucky, she says. Her Alexander Village, Vista, and Estates residential developments were going to create 300 carbon neutral homes for three income levels of people. Working with the developer Contempo, Inc., they even built a few prototypes up front. Escalante was completing construction permits last summer when she began to hear rumors that the developer was foundering because of a lack of credit to pay for the project. It turned out to be true. She wasn’t able to get paid for the work her Palm Springs-based firm had already performed. Then the developer left town. “I did my best to collect and negotiate with them—even for 50 cents on the dollar,” Escalante says. “It didn’t happen. The guy disappeared from town. He had great intentions.”

Chicken and the egg: credit and the recession
Such stories are becoming quite common in the beleaguered design and construction industry, and a lack of financing for projects seems to be just one aspect of this deep recession that is punishing architects. Over the past year, architects and their clients have had to deal with dysfunctional credit markets, a burst housing bubble, and a generally weak economy that’s resulted, thus dropping tax rolls for municipal governments and slashing endowments for institutional clients, all of which have taken a toll on the design and construction industry.

Credit crunches are stalling high-profile, iconic projects by world famous architects like the Chicago Spire by Santiago Calatrava, Hon. FAIA, and work-a-day projects in towns and cities across the nation. AIA chief economist Kermit Baker, PhD, Hon. AIA, says that the recession began with a “unique and focused” problem in the credit and banking system that brought lending to a halt in September. The federal government’s Troubled Asset Relief Program (TARP) bank bailout was meant to restore the structural deficiencies in credit markets. But, since then, instability has spread to the rest of the economy, which has hampered banks’ willingness to lend, if not their ability to. “It’s very difficult to disentangle those two things now,” Baker says.

Whereas previously financing was frozen due to structural illiquidity in the marketplace, today banks’ hesitancy to lend is a rational response the poor economic climate, Baker says. Real estate and construction loans that might have been immediately approved in a boom time are all looking a lot riskier today. Commercial property values have declined by 25 to 35 percent, and thus commercial construction projects are predicted to decline by 25 percent this year and 15 percent next year, according to the last AIA Consensus Construction Forecast. Consumers’ confidence has eroded along with their willingness to spend, creating less demand for retail stores. Unemployment is near 10 percent with more and more workers losing their jobs, creating less need for office space. Overall, a 16 percent drop in nonresidential construction activity is forecast for this year and a 12 percent drop is predicted for next year.

On architects’ end, 48.2 percent of firms said credit has become much more restricted and 30.8 percent said credit is somewhat more restricted, as reported in the March 20, 2009, edition of the Architectural Billings Index (ABI). Released in July, a Federal Reserve survey of senior lending officers at 55 domestic banks and 23 domestic branches and agencies of foreign banks reveals a somewhat similar picture. Credit is still tighter than long-term averages, but not as tight as it was in the depths of the recession this winter, near when the ABI dipped to its lowest level ever in February—33.3. Forty-six percent of lenders said standards for commercial real estate loans had tightened over the last three months. Also, 43 percent of lenders said lines of credit for existing customers to be used for commercial construction loans had decreased over the past three months. Typically, lenders say they are tightening credit because of weakness in the overall economy and a reduced tolerance for risk.

AIA federal relations is currently working on regulatory or legislative proposals to unfreeze credit for construction projects, notes Senior Director for Federal Relations Andrew Goldberg, Assoc. AIA.

Downgrading
John Urban of Urban Architectural Group in Matthews, N.C., says that 75 percent of the projects his firm has been working on are on hold due to constricted credit. He’s had to downgrade seriously the size, scope, and quality of the work he signs up for to keep his five-person firm afloat. “What we’re relying on are tenant upfittings and small remodeling projects,” he says. “Now it’s about whoever has the money in the bank or is only borrowing very limited funds.”

His firm specializes in commercial real estate and single and multifamily housing—all sectors of the design and construction industry that have been hit especially hard by the recession.

Urban says he saw signs in the fall that credit for his design projects was going to be difficult to come by. By January and February, projects started seizing up. This included several housing projects, several shopping mall designs that were finally left for dead in April, and office space projects from 40,000 to 100,000 square feet. “The commercial office retail market is in a complete stranglehold,” he says.

Don Swofford, AIA, an architect in Charlottesville, Va., says the lack of project financing is pushing his seven-person design consulting and historic preservation firm to the brink. As a consultant who works with other Charlottesville architecture firms, he’s seen six projects put on hold due to a lack of financing. This includes a $10-12 million condo project, another $30 million condo project, and a $20 million hotel—perhaps the building type that’s seen the largest declines in construction during this recession.

“We’re barely making it from payroll to payroll,” Swofford says. “We’ve all said: ‘In 30 days, we could be in bankruptcy court.’”

Swofford says he fears that federal regulators have forced lending standards for local banks to be too stringent in the wake of federal bailouts of failing banks. He hopes that as design and construction costs fall with the prolonged recession, top-tier developers and clients will be too tempted by reduced costs to stay out of the market much longer and will begin pressing banks for more money. That’s what helped to end the design and construction recession in the early 1980s, he says, and he’s cheering for a happy instance of history repeating itself.

As always, diversify
Escalante never intended to get involved in the mercurial California residential design industry. Despite her firm now being widely known for residential projects, Escalante Architects began in 1997 as a firm doing public and institutional work, primarily education projects. In 1999, she designed a house for a client on a whim, she says, and quickly found herself profitably enmeshed in the past decade’s high-end housing boom.

But, in 2006, a colleague told her that the residential market was a bubble on the verge of bursting and that she should consider diversifying her practice. Eventually, she took the advice and began expanding her services and adding staff, including a planner, an engineer, and economic development and marketing staff to reach out to the same institutional clients she had originally sought and would now need to keep her eight-person firm alive. “It took two years of knocking on doors,” she says, to diversify her client base and insulate her firm from the credit woes stymieing the residential design sector.

Today, Escalante’s residential projects that still stand a good chance of being built are more likely to be financed by public agencies, like affordable housing developments, with a few high-end residential properties sprinkled in as well, “but,” she says, “that’s not what sustains our office.”