A Couple of Commercial Real Estate Anecdotes

Here's a quick follow up to my post yesterday about two former Harry Macklowe-owned office properties in Manhattan, the Worldwide Plaza and 1540 Broadway.  Apparently the deal between Fillmore Capital Partners (the holder of the mezzanine debt on the defaulted properties) and Deutsche Bank (the former holder of the senior debt and current owner of the properties) could not reach a deal.  The contract was expected to be signed yesterday, but for some reason the parties didn't finalize the deal.  According to the article in the Wall Street Journal, Deutsche Bank has been trying to sell the properties since early 2008 when Macklowe defaulted and handed over the buildings.  The bank supposedly had bids in hand above $2 billion when NBC Universal walked away from signing a lease in the Worldwide Plaza.  To quote the Journal "That discouraged potential buyers who calculate returns on investment based on how much cash buildings generate from rent collections."  I like that.  Potential buyers in 2008 and 2009 apparently like to calculate returns based on actual cash flows from the building.  Whereas commercial real estate investors prior to the credit crunch calculated returns based on imaginary ponzi fairies that visited them in their dreams.  This sort of explains why we have a credit crisis.

Calculated Risk reports, via the Boston Globe, that the John Hancock Tower in Boston will be auctioned off March 31st.  The Hancock Tower was part of the Broadway Partners 2006-2007 leveraged buying frenzy.  Broadway paid $1.3 billion for the building in 2006 and the current value of the building is estimated at between $700 and $900 million.  Something about cash flows and rent being related to valuation...I'll have to check my notes.  In any event, anyone interested in bidding on this one, give me a call.  I've been looking to acquire a trophy property or two, but I'm a little short on the cash.  If we rub a few cents of equity together, line up the financing from Deutsche Bank, then maybe Deutsche can just shovel it into the TALF, and it's a win for everyone.  Well, almost...

Then again, maybe we don't want to bid too soon.  After all, the carnage in the commercial real estate market is really just beginning.  A friend sent along a link to a great article in DealBook yesterday about the wreckage following Sam Zell's ingenious sale of Equity Office Properties to Blackstone Group for $39 billion in 2007 (aka "the top".)  Blackstone flipped hundreds of the buildings for $27 billion to several overeager buyers.  Many of the 16 companies that bought Equity Office buildings are now stuck with significant debt while the value of the assets are plummeting as they struggle to fill empty office space.  Harry Macklowe was just the first to blow-out.  Maybe I'll wait to make a move on that trophy property purchase after all...    

     

Broadway Partners Defaults, Causes Turmoil in CMBS

The Wall Street Journal's Property Report has a great article today detailing how complicated (translation: ugly) a CMBS deal can get when a default is involved.  At the center of the new turmoil in the CMBS market is Boston's famed Hancock Tower and Broadway Real Estate Partners, one of the poster-children of the debt-fueled commercial real estate binge that based its investments on unrealistic cash flow assumptions.  I wrote about Broadway back in April 2008.  Broadway had extended its short-term loan on several properties and was looking for creative new ways to raise capital.  At the time, I enjoyed analyzing and speculating about the impending fissures in the commercial real estate market which was still viewed as immune to the credit crisis.  During the peak of the credit boom, I had often wondered why on earth anyone would buy an illiquid asset with a significant amount of short-term financing that carried much higher rates than the sub-3% cap rate from the property.  What was I missing?  Why did the math just not make sense to me?  Was my abacus just not calibrated correctly?

The answers to my crazy questions are quite clear now as deal after deal struck in 2007 is winding up in complicated angry negotiations with lenders and investors.  Broadway's recent default on the loan tied to the Hancock Tower, and other buildings, will certainly keep the lawyers gainfully employed.  Complicating the matter, the $700 million loan was securitized into mezzanine debt split between nine investors, including Five Mile Capital, BlackRock, RBS (now part of the UK government), Lehman (now bankrupt), and State Street (still kicking, just a really bad day in the market yesterday.)  At least State Street didn't buy the mezz debt because it thought it was a nifty investment, State Street seized the collateral from Lehman after Lehman defaulted on a repo.  What makes this whole kerfuffle somewhat interesting, particularly to the lawyers, is that the foreclosure process is not straight forward in a mezzanine deal.  The property is to be appraised and those investors who are the most junior according to the appraised value, get to decide whether to foreclose.  With commercial real estate values plummeting, and very little property actually changing hands due to a lack of financing, finding an appropriate valuation for the property that everyone can agree on is perhaps not so easy.  Consequently, determining who is the junior creditor who has control over the foreclosure is disputable.  And dispute they will.              

Broadway Partners Honored With "Mini-Macklowe" Award

Broadway Partners, a New York real estate investor, is coming dangerously close to emulating its apparent hero Harry Macklowe, the New York real estate developer who defaulted on his debt obligations earlier this year. According to the Wall Street Journal's Property Report, (which requires a subscription so I cannot link) Broadway Partners, an extremely aggressive office property investor, is currently peering down from the top of the commercial real estate ponzi scheme and realizing that it may be the greatest fool. Apparently, Broadway acquired billions of dollars worth of office properties using short-term debt near the peak of the credit cycle and is now desperately trying to avoid handing over the keys to the trophy properties it has acquired over the years. The investment partnership will try to raise equity from its investors to buy back debt at a discount from the debt-holders. Furthermore, it is attempting to offload several properties in Houston and San Francisco in order to raise cash. Will Broadway be able to pull all of this off before the first portion of the short-term debt comes due in January 2009? That depends on how much the credit environment improves in the next six to nine months.
When I read stories like these in the press (please see my previous post about Frank Lembi for another example of a real estate titan who is punting properties after a debt-fueled buying spree), I start to wonder what all of these supposedly experienced and brilliant real estate investors were thinking when they paid sub-3% cap rates to buy investment properties. I understand that some markets are better than others. It is certainly the case that you should see 10% cap rates in a crummy market like Detroit that has horrible fundamentals and significantly lower cap rates in markets with strong fundamentals like San Francisco or New York. But why would anyone ever pay a cap rate that is less than the 10 year note for an illiquid asset? I was recently told by a real estate broker when comparing higher cash flows in a different city to properties in San Francisco that "San Francisco is not a cash flow market. It's an appreciation market." That has certainly been the case for the past few years and could continue indefinitely if investors weren't buying properties with enormous amounts of leverage, particularly short-term debt. This is how San Francisco became a "Negative Cash Flow Indefinitely, GET ME A BID FOR THIS BUILDING!" market.
While I'm busy honoring Broadway Partners for its real estate folly, I might as well hand out another award. This one goes to Sam Zell. I'll call this award: "I sold the high! Ha ha, suckers!" Sam Zell, for those who don't know, sold his REIT Equity Office Properties for $36 billion in early 2007 right before the credit markets took a dive. That's some good timing!