When Harry Macklowe saw his bet on the Manhattan office market collapse in 2008 and was forced to default on a $5.8 billion loan, his lender, Deutsche Bank, absorbed much of the immediate financial wallop.
Seven years later, a resurgent Macklowe is betting the farm on Manhattan’s luxury condo market through 432 Park Avenue, a project he’s referred to as “the culmination” of his career. But if this wager were to turn sour, someone altogether different could share the pain: a foundation dedicated to fighting malnutrition and disease among children in developing countries.
The Children’s Investment Fund, a U.K.-based hedge fund that has donated a large share of its profits to its eponymous charity, is the senior lender on what will be the Western hemisphere’s tallest residential building, with a commitment of $400 million. The fund has also extended a $450 million construction loan to Zeckendorf Development for the upcoming condo project at 520 Park Avenue, and a $660 million loan to Silverstein Properties for its condo and hotel project 30 Park Place in Lower Manhattan. In total, the fund has agreed to lend at least $1.7 billion to condo developers in Manhattan since 2011.
A new lending era
The fund’s involvement is part of a seismic shift in the financing of new residential construction. Not a single one of Manhattan’s seven largest luxury condo towers currently under construction or pre-development is being financed by a senior construction loan from a domestic bank, according to a review of public documents and news reports conducted by The Real Deal.
“What’s happening is that they [domestic banks] have become a little more restrictive, they don’t really compete with overseas banks,” said Kevin Swill, chief operating officer of the Carlton Group, a real estate investment banking firm that has arranged financing for a number of projects, including 432 Park and 125 Greenwich Street. “The market is definitely very competitive, but the competition right now is coming from these overseas institutions.”
Traditionally, major residential construction projects in Manhattan were financed by syndicates led by domestic banks such as Wells Fargo and Bank of America. But in recent years, more unconventional lenders – many of them foreign — have stepped into the limelight.
Two of the seven tallest projects (432 Park and 30 Park Place) are financed by the Children’s Investment Fund through an affiliate, Talos Capital Limited. Singapore’s United Overseas Bank is the primary construction lender on two other projects – the Hines’ Jean Nouvel-designed MoMa Tower at 53 West 53rd Street and 125 Greenwich Street, being developed by Michael Shvo, Howard Lorber’s New Valley Group and Bizzi + Partners. The Bank of China is financing Vornado Realty Trust’s 220 Central Park South with senior and mezzanine loans totaling more than $1 billion. The two final (and tallest) developments, Extell Development’s Nordstrom Tower at 225 West 57th Street and JDS Development and Property Markets Group’s 111 West 57th Street, don’t appear to have secured construction loans yet.
A fund with a mission
The Children’s Investment Fund (TCI) is the most active – and most unconventional – backer of Manhattan’s supertall luxury towers. Founded in 2004 by Christopher Hohn, TCI is one of the largest hedge funds in Britain. Since its inception the highly profitable fund has donated more than $1.9 billion to the Children’s Investment Fund Foundation, a charity run by Hohn’s ex-wife, Jamie Cooper-Hohn.
Initially, TCI was contractually obligated to donate a large chunk of its profits to the foundation, which seeks to improve the lives of children in developing countries. But the Hohns split in 2012, and so did the fund and the foundation. Since 2014, TCI is no longer obliged to donate to the foundation but Hohn remains a trustee of the foundation and will likely remain a major donor, according to the Daily Telegraph.
TCI’s ties to charity make for an interesting contrast: A hedge fund that has done more than any of its peers to fight childhood poverty is now also the biggest financier of swanky housing for the uber-rich in Manhattan.
The fund made its first widely publicized foray into Manhattan’s luxury condo market in 2011, when it lent Macklowe Properties and CIM Group $250 million for their conversion of 737 Park Avenue. Its most recent loan, for Zeckendorf’s 51-story condo project 520 Park Avenue, closed last October.
For a hedge fund like TCI, financing condo construction is attractive because of high returns. The fund’s 432 Park Avenue loan to Macklowe and co-developer CIM has an interest rate of around 10 percent, according to sources, and the rates on loans for 520 Park Avenue and 30 Park Place are not far behind. This is more lucrative than average non-recourse loans for ground-up condo construction, which typically carry an interest of five to 6.5 percent, according to David Eyzenberg, a principal at Avison Young’s Capital Markets Group. Unlike most banks, hedge funds are under pressure to regularly produce double-digit returns, which essentially limits them to riskier real estate loans.
A spokesperson for TCI declined to comment. Michael Barker, an attorney at Fried Frank who represented the fund in its Manhattan financing deals, would not speak on its behalf, but pointed to the general attractiveness of the New York market. “New York real estate is seen as an increasingly solid investment,” he said. “It has survived ups and downs throughout its history.”
“They really want to get the money out”
Other foreign construction lenders make do with far lower returns than the Children’s Investment Fund. The Bank of China’s $600 million senior construction loan to Vornado for 220 Central Park South, for example, comes with a floating interest rate of 2.92 percent, according to the real estate investment trust’s most recent public financial statement. The bank also gave the developer a mezzanine loan for the project with an even lower interest rate of 2.5 percent. In all likelihood, these loans are cheaper because they are secured against the REIT’s sizable balance sheet, according to sources. A spokesperson for Vornado declined to comment.
Lenders like Bank of China are drawn to construction financing in Manhattan not because of high returns, but because of its perceived safety. “They probably see what most people see, which is that the residential market is booming,” said Carlton’s Swill. “It’s still the safest of all real estate markets when it comes to new development.”
It probably doesn’t hurt that foreign banks often have far lower costs of capital than their U.S. rivals, meaning they can in turn live with lower rates on their loans. In China, for example, rates that banks can offer depositors have long been capped by the government.
“International banks look for lower yields on their loans,” Swill said. “They have so much capital that they need to deploy and they really want to get the money out.” The Bank of China could not be reached for comment.
A consequence of this inflow of foreign lenders is that construction financing appears to have become cheaper in general. “We’re doing deals in exactly the same range,” said Ayush Kapahi of the real estate capital advisory firm HKS Capital Partners. “The interest rate is a function of the magnitude of borrower in terms of real estate holdings. Pricing can be as cheap as what Vornado is borrowing and sometimes even cheaper. You can’t imagine.”
High risk, high return
So are foreign financiers inflating the next lending bubble? Most experts don’t think so. “The construction lending market has been extremely disciplined,” said Shawn Rosenthal, executive vice president in CBRE’s debt and finance group. “I don’t think the Children’s Fund is lending on risky projects. They have modest leverage and a fair level of interest rates.”
In 2008, many lenders got burned because their loans sometimes covered as much as 80 percent of a construction project’s cost, leaving them vulnerable when property values plummeted. But in the current lending cycle, this doesn’t appear to be the case. At 432 Park, CIM has raised 60 percent of the project’s cost in equity. Since senior lenders get paid first in the event of a default, the building’s value would have to drop dramatically for TCI to lose any money. At 220 Central Park South, the Bank of China’s loans cover a much higher share of the project’s total cost, around two-thirds. But the risks appear to be low. This week, Vornado announced it has already sold $1.1 billion worth of condos in the building, meaning the bank can consider its $1.05 billion loans repaid.
There is no doubt that condo construction lending is risky and some developers may well default. But there are indications that lenders are becoming more cautious as the luxury market slows. “The Children’s Fund on a new loan today would be just as conservative (as domestic lenders),” claimed Rosenthal.
For developers, the influx of foreign lenders is a boon. They not only often offer lower rates, but a simpler loan structure. Domestic banks typically lower their risk on major construction loans by bringing other lenders on board in a syndicate. A menagerie of parties involved can complicate things when loans need to be renegotiated. In contrast, the Bank of China and the Children’s Investment Fund keep entire loans on their books, according to sources. This can offer developers much-needed flexibility.
Perhaps most importantly, lenders like TCI offered developers funds at a time when large domestic banks were still recovering from the crisis and adjusting to new regulatory requirements. Harry Macklowe is the quintessential example. The developer and CIM secured their construction loan for 432 Park in 2012, a mere four years after Macklowe’s spectacular multibillion-dollar default.