Amid recession and geopolitical turmoil, companies of all stripes are as conservative as Bill Bennett, the former drug czar and secretary of education. They're cutting back. They're having trouble paying bills, including rents on office, retail and industrial space. Although everybody wants to see the end of the recession, virtually nobody -- least of all bankers -- wants to start putting money into new growth initiatives until they're sure the worst is over. This vicious cycle makes a near-term recovery unlikely.

"You can just feel it," said Richard Gatto, executive vice president of The Alter Group, a big developer based in Skokie, Ill. "No one in Corporate America wants to even think of growth or adding people. It's such a wait-and-see attitude that it's just frozen everyone."

If this were 1991, the scenario would include a virtual shutdown of lending for real estate projects. But, so far, this cycle has been kinder and gentler because the industry didn't overbuild in the good years to the extent it did in the 1980s boom. Around the start of the current recession, in the second quarter of 2001, the national office vacancy rate was about 11%, compared with a peak of 18% during the recession of 1990-91, according to statistics from Northbrook, Ill.--based Grubb & Ellis Co. Lenders have adopted more rigorous underwriting practices, and equity capital is more difficult to raise via the stock markets and other sources. Still, there is some money available -- for the best projects with minimal risk.

"Given that the industry has adopted appropriately more strict underwriting, there's lots of money still out there for the right deal," said Peter Fioretti, CEO of Charlotte, N.C.-based Mountain Funding, a lender that provides private financing alternatives to developers and owners of commercial real estate.

So rather than a lock down in the capital markets, a stratification has taken hold: well-financed developers can obtain funding for projects as long as they are pre-leased to financially solid tenants -- and usually at lower loan-to-value ratios than borrowers could get two years ago. Less established developers and speculative projects are pretty much out of luck.

Edward Shugrue, chief financial officer of New York-based mezzanine lender Capital Trust, attributes the relatively easy money in these hard times to the fiscal discipline of developers and REITs, who kept their balance sheets clean in the 1990s boom. That's why, he says, the industry has not yet seen many fire sales of distressed properties.

Over the past several months, properties that have been sold have gone at prices higher than Houston-based Hines, for one, was willing to pay. "We've been surprised." said Charles Baughn, executive vice president at the company.

On the other hand, some properties carry the stigma of the collapsed high-tech investing boom. Fioretti points to a 100,000 sq. ft. building in Chicago that was outfitted for telecommunications tenants. As recently as mid-2001, he says, it was attracting purchase offers of about $15 million. Now, no one's interested. It's not so much a matter of price. Rather, buyers don't want to take a risk with the building's tenant profile -- small telecom companies struggling financially to survive.

Financing options multiply

Another factor helping to ensure liquidity is that commercial real estate finance has grown vastly more sophisticated. In the past several years, instruments such as mezzanine financing, commercial mortgage-backed securities (CMBS) and equity infusions have emerged.

"Just a few years ago, borrowers could choose from only three or four standard mortgage programs," wrote Jim Reichek, managing director of the Kushner Cos. of Florham Park, N.J., in an October paper on the topic. "Now, from Wall Street and the larger institutional banks to S&Ls, to Fannie Mae and Freddie Mac, to regional commercial banks and life insurance companies, the myriad of options has grown tremendously."

Debt markets tighten, but open for business

Given the rocky equity markets, it's no surprise that most of the new money is coming in the form of debt. Even for publicly traded REITs, debt is where it's at. Through October, REITs in 2001 had raised a total of $12.69 billion in capital, and 64% of that, or $8.17 billion, was debt, all of it unsecured, according to the National Association of Real Estate Investment Trusts (NAREIT). In 2000, debt accounted for 73% of the $10.38 billion raised by REITs.

Karen Dorigan, chief investment officer of CarrAmerica Realty Corp., a Washington, D.C.-based REIT, noted that REITs with strong balance sheets and good credit ratings still have ready access to bond markets. They can also obtain financing from banks.

For example, CarrAmerica closed on a three-year, $500 million credit facility in June with a syndicate of banks led by J.P. Morgan Chase. The line carries an interest rate of 70 basis points over 30-day LIBOR (London Interbank Offered Rate), which is similar to the terms of the company's previous facility, according to CarrAmerica's third-quarter report. In fact, Dorigan said the terms are similar to the credit line set up two or three years ago, and that the company could borrow as much money on the same terms today.

Although interest rates that CarrAmerica and other borrowers are paying today are near historic lows, lending standards are more rigorous. Lenders are lowering loan-to-value ratios, requiring more pre-leasing and equity from developers, and drilling deeper into the credit quality of tenants.

For example, to obtain financing to build a speculative office building, lenders now typically require the developer to ante up 40% of the project cost in equity, up from 20% to 25% two years ago, said George Emmons, executive vice president at Key Commercial Real Estate, a Cleveland-based lender. But even with a 40% to 50% equity stake in a project, a developer today would find it difficult to obtain financing for a speculative office building. By contrast, a build-to-suit project that's guaranteed to be 90% occupied would require a developer to put up only 15% to 20% of the cost in equity.

Baughn of Hines said a developer/owner with a credible rent roll just six months ago could have borrowed 70% of a project's value. Today, that loan-to-value ratio would likely not go above 60%.

On the other hand, when it comes to the refinancing of existing buildings, investors have a tenant roster and a track record of performance at their fingertips, so they don't have to guess when a project will be completed or what tenants will occupy the building. If a life insurance company, for example, buys the mortgage of a building that was constructed for a big company like AT&T, that life company isn't gambling on a builder or developer. "They're looking right through the lease to AT&T," Emmons said.

Little new construction

A meager amount of new building is expected over the next few months. Projects that will go forward are ones that are pre-leased to tenants with spotless credit and projects with quality sponsorship, Dorigan said. CarrAmerica, for example, has about $100 million in development under way, down from a peak of $500 million in 1999.

The type of development also has shifted dramatically. Three years ago, about 70% of CarrAmerica's development involved speculative space with little or no pre-leasing. Today, Dorigan said, 85% to 90% is build-to-suit or substantially pre-leased properties.

In addition to the nature of development, location also is critical in today's financing markets, according to Dorigan and others in the industry. "Washington, D.C., for example, attracts capital much more easily than a Dallas or Atlanta or other markets that have [experienced higher office vacancy rates]," Dorigan said.

Cushioned by the presence of the federal government, Washington, D.C.'s overall office vacancy rates have remained at about 3%, according to Colliers International, while vacancy rates in Atlanta and Dallas have hovered at close to 13% and 20%, respectively.

Liquidity isn't spilling into all sectors. For hotels and senior living centers, there is a veritable drought, according to Brett Smith, managing director of client management for the real estate capital markets business at Charlotte, N.C.-based Wachovia Securities. In a special report on the state of the hotel industry following the Sept. 11 terrorist attacks, NREI reported in its November issue that tighter lending standards have put new hotel construction on the back burner. The shaky economy also caused Irving, Texas-based FelCOR Lodging Trust Inc. to cancel its planned acquisition of Washington, D.C.-based Meristar Hospitality Corp.