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Downtown San Jose towers face tough financing amid housing shortage

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SAN JOSE – A trio of proposed housing towers in downtown San Jose may face a difficult search for construction financing due to an increasingly uncertain and uneven economy.

Preliminary plans have been formally filed for two new residential buildings in Downtown San Jose to replace the proposed office tower at the corner of North Fourth Street and East Santa Clara Street in San Jose near City Hall.

Street-level nighttime view, concept, of the 600-unit residential complex at 147 East Santa Clara Street in Downtown San Jose. (BDE Architects) (BDE Architects)

According to Eric Hayden, founder of Urban Catalyst, the real estate firm leading the project’s development, the housing towers could accommodate 600 to 700 residential units, although the actual number is more than 650 apartments.

Separately, construction of an adjacent housing tower just below the approved block at North Fourth Street and East St. John Street could begin in about a year, according to Hayden, whose Urban Catalyst firm is also leading development at that site . ,

But all three of these housing towers are facing a problem that is becoming more widespread in commercial real estate by the day.

Despite the housing crisis, landing financing for new construction – even apartments – has become more difficult than ever.

Lenders demand financing models that force developers to foot at least half – sometimes more – of the cost of building a new housing tower.

Put another way, if a housing project costs $200 million to build, currently a construction lender will insist that the loan will not exceed $100 million of the cost, with the developer and its equity partners taking over the remainder. Will cover $100 million.

Evening view, concept, of a 600-unit complex of residential towers at 147 East Santa Clara Street in downtown San Jose.  (BDE Architects)
Evening view, concept, of a 600-unit complex of residential towers at 147 East Santa Clara Street in downtown San Jose. (BDE Architects)

“In recent years starting in 2008, 2009, 2010, lenders required a loan-to-cost ratio of 65%,” Hayden said.

This means that for the same $200 million housing complex, lenders were willing to finance $130 million of the cost, while developers and their partners would provide $70 million of the construction cost.

“Now, they prefer a debt-to-cost ratio of 45% to 50%,” Hayden said. “Sometimes it’s even less than 40%.”

This means that developers and partners are forced to spend $100 million to $110 million for the same hypothetical housing high-rise – sometimes as much as $120 million out of a total construction expenditure of $200 million.

As a result, in many cases residential towers are not being built, even despite the glut of proposals and the apparent lack of affordable or market-rate housing.

The housing project called Echo, which will be built at North Fourth Street and East St. John Street, will have 389 residences.

Hayden estimates construction of the Echo Tower could begin in about a year, depending on when the city approves the final design of the project as well as formal building permits.

Two icon housing high-rises down the block at East Santa Clara Street and North Fourth Street are just entering the preliminary project review phase, during which the developers will seek formal feedback from city staff.

“We are looking at non-traditional sources of financing for the two new Icon Housing towers,” Hayden said.

Urban Catalyst has started looking for an insurance package that will guarantee operating income for housing towers. The guaranteed income stream can make the project more attractive to construction lenders.

These new Icon towers will be built in phases of possibly 300 units at a time, depending on how many units will be allocated to each of the two residential high-rises.

Urban Catalyst decided to convert the office project into a housing development due to the brutal market for office buildings, which is facing rapidly rising vacancy levels.

Even if the city approves the housing development that will replace the original office tower at 147 East Santa Clara Street, it is possible that the renovated development may still face considerable hurdles.

“Lenders are risk averse,” Hayden said. “They are raising the barriers to obtaining construction financing.”

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