Divorce, developer style

Irreconcilable differences over pricey conversion of Manhattan House

Mar.March 06, 2008 04:15 PM
NewKalikowpic.jpgIt was supposed to be a day of triumph for real estate mogul Richard Kalikow and his staff overseeing the conversion of the 583-unit Manhattan House into luxury condos.

Less than a week before, on March 30, 2007, New York State’s Attorney General had signed off on the $1.1 billion condo conversion plan for the storied East Side property, on 65th between Second and Third avenues. That afternoon, Kalikow staffers had mailed the last of the sales offerings out to the building’s tenants, a benchmark that took 18 months to reach.

But there would be no congratulatory messages from majority partner Jeremiah O’Connor that day. Instead, he served Kalikow with a legal notice demanding the commercial version of a divorce.

The pair’s companies “have had numerous disagreements,” O’Connor’s lawyers would later state in a lawsuit. And they have been “unable to resolve their disagreements” (a point Kalikow denied).

Many of those differences, apparently, went to the heart of the project itself: What kind of apartments would sell — big ones or smaller ones? How much renovation did the building need? How should the project be marketed?

The breakup was sealed when a judge ordered one party to buy out the other.

Now, nearly five months since Kalikow finally agreed to sell his share of the massive property — reluctantly and under court order — to O’Connor, the imprint of Kalikow and his staff have largely faded from the project.

Today, the branding effort is in full bloom: plastering ads in magazines and newspapers featuring Grace Kelly, a former resident of the landmarked building, alongside the project’s broker, Dolly Lenz, the vice chair of Prudential Douglas Elliman and widely regarded as the top agent in the city. House Beautiful has an eight-page spread profiling one of the model units designed by interior designer Jamie Drake in its March issue.

Beyond the polished surfaces, the developer has been busy putting in some 6,500 new windows, installing a new central air conditioning system and completing an upgrade of the electrical and plumbing systems. O’Connor has renovated 40 apartments and aims to complete an additional 180 apartments by year’s end. (They currently have about 335 vacant apartments.)

About 51 condominiums are under contract with agreed deals on another 20 units, the developer said. Units sold range from studios to four-plus bedrooms ranging from $1,200 to $2,400 a square foot.

But before the luxury condos — with their wood-burning fireplaces, mahogany doors, sun-drenched living rooms and capacious balconies — were fodder for the pages of glossy real estate catalogues, the classic white brick complex was a cautionary tale for bad real estate marriages.

A record amount

The causes of the dispute over the costly condo conversion — the developers paid $623 million for the building, or a record of more than $1 million per apartment, at the height of the market — have remained largely a mystery, overshadowed in part by a parallel lawsuit launched by tenants against both developers.

Today, both partners are bound by confidentiality agreements not to discuss the matter, and the true story of what happened behind closed meeting doors may never be known.

Still, court documents and interviews with some of those caught in the middle suggest an outline of what went wrong, and offer a behind-the-scenes glimpse into a real estate feud that one contractor involved crowned “one of the most unpleasant experiences of my life.”

Optimistic start

It began, like most marriages, with high hopes for the future. And in real estate circles, the two partners were the equivalent of a power couple.

JeremiahW. O’Connor Jr., known to many as Jerry, had acquired and developed more than 10 million square feet of regional shopping malls in the 1980s, and has been managing private equity funds since 1994. Richard Kalikow, scion to a powerful real estate family and the cousin of former MTA chairman Peter Kalikow, had a track record for high-flying deals. In the 1980s, he’d converted more than 7,000 apartments to condos.

In the 1990s, he founded Max Capital Management Corp. with Adam Hochfelder. At its peak, Max Capital owned and managed 8 million square feet of office space worth $2.7 billion, including 230 Park Avenue, the Condé Nast Building and the Associated Press headquarters at 450 West 33rd Street.

On a side note, Kalikow and Hochfelder later suffered a nasty split detailed in a number of press accounts and a lawsuit of their own. After Kalikow sold his 60 percent share of the business to Hochfelder, he sued and accused him of withholding information that resulted in an unfair buyout price — an allegation that Hochfelder denied.

But back to our power couple: One source familiar with the project’s origin said that the matchmaker of the Kalikow-O’Connor pairing was Howard Michaels, chairman and chief executive officer of the Carlton Group, the real estate investment banking firm that eventually arranged an $840 million equity and condo conversion financing package for the joint venture.

He put them together, the story goes, after they came in individually as top bidders in earlier rounds held by New York Life Insurance Company to sell the property. (Michaels did not return calls seeking comment, and neither partner would discuss how their courtship began.)

On its face, the pairing made sense — Kalikow had a history of managing high-class properties, O’Connor of investing in them. Under the terms of the deal, Kalikow and his ownership entity, Alpha Manhattan LLC, was the operating partner, running the day-to-day operations, while O’Connor’s ownership interest, ONA Manhattan House LLC, held the majority share.

Winning bidders

Together, Kalikow and O’Connor outbid some of New York’s biggest real estate names to win the right to buy the Manhattan House for $623 million. The vanquished back in October 2005 included Jerry Speyer, Aby Rosen, the Zeckendorfs and Dune Capital, among others.

“It’s location, location, location,” O’Connor crowed to a reporter at the time. “It’s quality, quality, quality.”

The deal set a national record, as the highest per-unit price paid for a single residential building slated for condo conversion. (The sale would later be eclipsed in total dollar value by deals like the purchase of Stuyvesant Town.)

In retrospect, the seeds of the nasty divorce may well have been present even on the day of the big purchase: In the overheated real estate market of the time — where the speed and audacity of the bid won the day — the newly paired moguls couldn’t have had much time to discuss their respective “visions” for the property, before throwing their chips into the bidding pool and hoping to emerge victorious. The high price, with its resultingly small cap rate, left “that much less margin for error,” noted one observer at the time.

Still, both partners clearly had high hopes for the property. An initial report filed with the state attorney general’s office estimated that the project would eventually be worth $1.1 billion.

“I toured the property personally with Jerry when it was on the market,” said Brett Buehrer, a principal at O’Connor Capital Partners and one of the partners involved with the project. “Jerry has always had a love for the building. It’s a great building in a great location, with quality of construction. It’s an irreplaceable asset.”

Modern revolution

Originally built in 1951, Manhattan House was considered revolutionary when it opened. Designed by Gordon Bunshaft, who also designed Lever House, the humongous complex had a spare frame with Bauhaus-style balconies, a white-bricked façade, glass-walled lobbies and a sloping driveway.

With some 583 units, ranging from studios to five-bedrooms and rising some 22 stories, the monolithic structure that runs between 65th and 66th streets, bordered by Second and Third avenues, is fronted by a rare two-lane east-west boulevard.

The recent land marking of the building may seem odd to those who don’t think of white brick as being architecturally important, but the building’s construction signified a departure — one of the first of its kind — from the more ornate architecture built in previous decades.

Most revolutionary, though, was the size of the apartments. The hard depression, war, and postwar years had convinced many developers to shrink the size of apartments. But the Manhattan House was based on the idea that people would pay for bigger ones. By buying up an entire city block, the architects were able to give each apartment at least two exposures to light and air. The building was constructed around a private park (the city’s second largest, next to Gramercy) so that each apartment looked out on a garden or the street, avoiding alley views.

In today’s market, with land prices and construction costs as they are, “you wouldn’t be able to amass a whole block to build like this,” Buehrer said. “The only thing you could do is build a 50-story tower. But this is built to the scale of the neighborhood.”

The building soon attracted luminaries as residents: In addition to Grace Kelly, Benny Goodman and Jackie Robinson, Bunshaft moved in himself. The Manhattan House was one of the few private apartment buildings where you had to pass an interview just to become a renter, and the waiting list was sometimes years long.

Tenant battle

By the time of the conversion, many of those tenants were elderly and were reluctant to move. According to press accounts, some 250 of the units were rent-stabilized.

The tenants began causing the developers headaches immediately.

By spring of 2006, some six months after the deal closed, more than 60 tenants had packed up and left. But others bitterly complained they were being harassed, and forced out with no place to go. Several hundred ponied up for a legal defense fund, and hired tenant lawyer David Rozenholc to fight the plan.

Rozenholc, an experienced litigator, had fought Donald Trump to a standstill at 100 Central Park South, when the developer wanted to evict long-time, rent-controlled and stabilized tenants, gut the building and combine it with the Barbizon Hotel. At one point, he represented the tenants of the Ansonia in their battle against that building’s new owners — one of the longest court battles in New York City’s history.

Negative stories began appearing in local papers, describing elderly tenants squaring off with rapacious developers. The situation reached epic proportions by the following November, when a 97-year-old tenant named Martin Burwick died of pneumonia within days of moving out. (His lease was due up in April 2000.) Tenants blamed the death on the stress of
eviction and construction at the site, which spewed fumes, dust, debris and, according to some claims, asbestos. Representatives for the developers denied responsibility, but the story didn’t play well.

“A man is dead, and it’s from the conditions in the building,” one tenant told the New York Post.

The media jumped on the developers versus tenants battle — it got mentions in the New York Times, New York magazine and many other publications. But behind the scenes, a different kind of battle was brewing between the developers themselves, and this one would have a much bigger impact on the pace of the development itself.

Different views

The lawsuits the two moguls filed against one another last spring tell starkly different versions of the events. Indeed, Kalikow’s lawyers claimed O’Connor concocted the disputes as an excuse to kick him off the project, and prevent him from receiving his fair share of the conversion profits. They claimed the disagreements were in the process of being worked out.

Whether that’s true is difficult to determine. But it seems clear from talking to independent entities involved with the project that Kalikow and O’Connor had starkly different ideas for the property. To hear some involved tell it, the disputes began almost immediately.

“We became aware of different views in very early meetings,” said one contractor. What followed was “one of the most unpleasant experiences of my life.”

“The O’Connor people,” said one person involved, “had a very different vision for the project than Richard did. They had a much more extensive renovation in mind. I think there was just differing views on what would sell, and what the market would support.”

Though barred from speaking about anything having to do with the project before the October settlement, O’Connor principal Buehrer and the main broker on the project, Dolly Lenz, were eager to share their vision for the property, and offered a tour of the current apartments on the market.

Overall, the current plan calls for a $150 million renovation of the building. Most changes are slated for completion by June. The designers are the big names of the day: Sasaki Associates, the firm that designed the 2008 Beijing Olympic Green, is redesigning the grounds, porte-cochère entries and driveways. The original builders, Skidmore, Owings & Merrill, are redoing the lobby. Randall Ridless, who designed the Burberry prototype store in London, has redone the rooftop area with a private lounge, bar and party area. The Roto Group, which designed the Children’s Museum of Manhattan, is creating the children’s play area. Exhale Spa and fitness center will open a resident-only gym, yoga center and spa in the building this spring.

“We wanted to create the premier condominium on the Upper East Side,” Buehrer said. “It’s a building with all the modern amenities, built to prewar standards.”

It’s unclear how much of this plan Kalikow signed off on. But by all accounts, it appears his vision called, at the very least, for a smaller price tag.

For instance, Buehrer said that the property had great location, and “great features with a great architectural pedigree. But we needed infrastructure in place to bring it to current standards. We needed to completely remodel the apartments — gut renovations.”

But Jin Lee, chief financial officer for Kalikow’s company Manchester Real Estate, told The Real Deal explicitly last winter that: “It’s not a gut renovation. It has the same layouts with expensive finishes.”

According to Buehrer, “to bring the building up to current standards, obviously, we thought we needed central air conditioning.”

With many of the apartments still occupied and not slated for renovation until current tenants moved out, that meant installing a chiller and running central piping to each door, so it could be installed in each redone apartment.

But according to one contractor, Kalikow fought against the plan, pushing for a much cheaper solution: individual window and wall units.

The battle may even have extended to the marketing materials, a tussle some claim rose to a level of vitriol behind the scenes in November 2006, at the same time that press accounts were focused on the battle with the tenants and the death of Burwick.

O’Connor’s lawyers claimed in the court documents that they informed Kalikow’s people that the marketing materials “were not of appropriate quality for the project.”

Rather than change the materials substantially, O’Connor claimed, Kalikow’s people hired the same company to design an inferior Web site, according to O’Connor’s legal claims. And when they showed O’Connor’s staff new versions of the marketing materials, his side claimed, they were essentially unchanged.

Perhaps most significantly, the developers apparently disagreed on the right mix of apartment sizes. In the court documents, O’Connor’s lawyers played up the differences, and accused Kalikow of making unilateral decisions and continually ignoring their input.

Kalikow’s “proposed renovations would create an initial inventory of 66 units, of which nearly 50 percent would be studio and one-bedroom apartments, and would include a number of contiguous apartments that could have been — but were not — included in combined units.”

That plan represented “a significant departure from the strategy of seeking to maximize the number of larger combination units because they sell at a significantly higher price per square foot than smaller units,” the lawsuit claimed.

Kalikow “never consulted” O’Connor “concerning this unilateral, significant and improper deviation from the strategy of maximizing the number of larger combination units,” the lawsuit contended.

In her affidavit, Jin Lee claimed that she sent O’Connor’s people revised marketing materials and a new proposal for apartment renovations just weeks before they demanded a split, and that the differences could be worked out.

But when read portions of the complaint by The Real Deal, Jonathan Miller, executive vice president and director of research for Radar Logic, which is not involved in the case, said the two sides appeared to be arguing for “two completely different philosophies,” and a legitimate argument could be made for both approaches. One approach calls for a more superficial renovation with more small apartments and selling them quickly; the other approach would invest more money in renovations, take more time and maximize the cost per square foot.

Because studios and one-bedrooms represent 40 percent of the market, they would likely sell faster than three-bedrooms, which during most quarters represents only about 5 percent of the market, a “smaller niche,” Miller said.

On the other hand, he noted the “axiom in Manhattan real estate is that larger contiguous space commands a higher cost per square foot.”

“One plus one equals two and half, so there is an argument you have the potential to achieve a premium simply by creating larger space,” Miller said.

As for market trends, at the time of the Manhattan House purchase, Miller said, there was some statistical evidence to suggest that units sold were “trending down in size.”

He added, “Overall average size of apartments that are selling are trending downwards slightly, but that’s not to suggest studios are selling and three-bedrooms aren’t.”

Liquidity in jeopardy

Whatever the cause of the disagreements, it began to affect the liquidity of the project.

For months, the partners funded the construction with “capital calls,” essentially their own money, because they couldn’t agree on the wording of a $30 million letter of credit demanded by the bank before it would release funds, according to the court documents. One person on the project suggested that since O’Connor’s plan called for a much more extensive renovation than Kalikow wanted, and required large amounts of capital, Kalikow had no incentive to expedite the arrival of bank funds.

It’s also unclear from the lawsuit whether both partners, Kalikow or O’Connor put up the additional funds. But by the time the partners finally split, O’Connor had put up a total of $119 million of his own money versus Kalikow’s $31 million, according to the court papers.

One thing that is beyond dispute is that the contractors on the project got caught in the middle.

The first to go was the renowned architect Annabelle Seldorf, who was brought in by O’Connor and fired by Kalikow, sources on the project said.

Also caught in the middle: Douglas Elliman, which Kalikow would eventually accuse of “colluding” with O’Connor to wrest control from him and sabotage the project. On May 12, 2006, O’Connor sent Kalikow a letter strongly objecting to “sending a default letter to Douglas Elliman.”

“You have never discussed the issue with us,” he wrote. “Under the terms of our joint venture agreement, taking any action that could result in termination of the Douglas Elliman agreement and assertion of any claim that Douglas Elliman is in default are major decisions that require our consent, and we will hold you accountable if you proceed without it.”

Kalikow replied: “In response to our default letter to Douglas Elliman, Howard Lorber [the chairman] contacted me yesterday and has agreed to resolve this problem … by dedicating certain professionals from Douglas Elliman to act as our contacts and give us direct access to their resources …. We disagree with you that sending a default letter to Douglas Elliman to get their attention is a major decision.”

In a letter dated November 2006, Kalikow’s representative Jin Lee accused Skidmore, Owing & Merrill of falling behind schedule, creating delays and at one point “wrongfully withholding its basic services. In her letter, Lee threatened to “seek compensation for any project delays.”

Exhale Enterprises landed in the crosshairs in early 2007. The high-end company has opened a number of trendy gyms offering yoga, workouts, massage and other spa services in the Hamptons, the Upper East Side and Los Angeles. It was a pet project of sorts for some on the renovation, who touted it along with plans for a rooftop lounge as essential to the high-end branding of modern “amenities,” so crucial to O’Connor’s vision.

In January 2007, Jin Lee terminated Exhale Spa, accusing it of being $50,000 over budget. “All along,” O’Connor’s staff wrote in a letter, O’Connor Capital Partners had told Manchester that “it viewed Exhale Spa as integral to Manhattan House’s image and had pressed Alpha to work with Exhale Spa to resolve any issues.”

O’Connor’s company was involved in the process of selecting building manager Kerry Smith, but was not consulted on his termination or the selection of Carl Reinlib as building manager, Brett Buehrer said in his affidavit.

A source close to the project who requested anonymity claimed, “In order to punish Jerry, I think Kalikow threatened to fire every single person, just to kind of put a halt to the project to get attention to himself, to make his position stronger. Everybody on the same day.”

By March, it seemed clear that communication between the two developers had almost completely broken down.

The interior design company Randall Ridless wrote to Jin Lee that on March 23, 2007, “we were met by Brett and Andy from the O’Connor group along with Howard Lorber and a group of people who appeared to be from Douglas Elliman. The tone of the entire group was hostile. To our surprise, they appeared completely unfamiliar with the existing space, its relationship/distance to the apartment building, and the evolution of the design to its current point.”

Signing the divorce papers

On April 5, 2007, O’Connor sent Kalikow a notice of intent to dissolve their partnership, the real estate version of divorce papers. The papers notified Kalikow that his company was in default under their limited liability contract, and that O’Connor was invoking his right to buy or be bought out under the terms of their contract.

O’Connor cited breaches of the contract — the dispute over the marketing materials, problems with financing, and the change in the mix of apartments among them. Finally, his attorneys complained that the monthly progress reports they had been getting were “unsatisfactory,” that they had repeatedly tried to get more information and that Kalikow had failed to address that concern.

O’Connor’s lawyers blamed Kalikow for months of delays in renovations and accused his staff of mismanaging the project, noting that “it cannot be known how many sales and how much revenue have been and will continue to be lost as a result.”

But Kalikow’s lawyers claimed the issues in dispute were many months old and in the process of being resolved.

“The type of project contemplated by the agreement is multi-faceted and involves many elements of decision making that require constant, ongoing negotiations with regard to details and particulars,” Jin Lee said in her affidavit. “This type of constant, ongoing negotiating has characterized the interactions between Alpha and ONA during the past 18 months.”

The issues cited in the notice of intent “have been steadily progressing toward resolution,” she stated. Lee claimed that she had sent O’Connor’s people revised marketing materials and a new proposal for  apartment renovations just weeks before the letter of intent and had been waiting for a response, and that they were in the final stages of coming up with the wording for a letter of credit that would have allowed them to avoid using capital calls.

She noted that the letter of intent coincided to the day with the completion of the mailing of the sales offering plan to all tenants at Manhattan House. That milestone brought Kalikow closer to reaching incentives that “ultimately may be as much as 40 percent of the company’s distributions to the Members, rather than Alpha’s percentage interest: 20.1 percent.”

Lee claimed that the black book approval allowed the partnership to move into the “profit-making phase” of the project. The contract gave Kalikow’s Alpha “an incentive to increase the value of the company’s property, an increasingly and disproportionately large profit percentage at certain levels of profitability.”

Each of the partners was to receive distributions from revenues proportional to their percentage interest in the company. But once each part received a certain level of return on their investments, Alpha’s share of the profits would begin to increase — eventually almost more than doubling from 20.1 to as high as 40 percent.

O’Connor thus “has a tremendous incentive to invoke the buy-sell procedure at this juncture to eliminate Alpha,” Lee contended.

Buyout ruling

In June, Justice Bernard J. Fried of New York State Supreme Court in Manhattan ordered that one partner buy the other out. The new owner wasn’t mandated, so the decision gave Kalikow the choice of buying out O’Connor within 30 days, or allowing O’Connor to buy him out.

On July 18, Rubenstein Associates issued a press release announcing that Kalikow had received financing from UBS to buy out O’Connor. But two weeks later, Kalikow issued a second release stating, “Alpha will not become the purchasing member pursuant to the Buy-Sell notice …. Alpha confirms that ONA will close the acquisition of Alpha’s interest in Manhattan Partners LLC no later [than] August 31, 2007.” Kalikow later claimed that O’Connor had scared away his backers by threatening to escalate the legal dispute.

There would be one more legal fusillade. In late August, Kalikow accused Douglas Elliman of colluding with O’Connor to wrest control from him and sabotage the project. He said that he had discovered that Lenz and other Elliman staff members held a number of secret weekly meetings with O’Connor’s team, revising plans and making decisions without him. He asked the Supreme Court to allow him to amend his complaint against O’Connor to include Prudential Douglas Elliman and to seek $75 million in damages as well as punitive damages against the company.

But Lenz said she is not aware of such a complaint ever having been filed against Elliman — or even of Kalikow’s request to do so.

It was not until Oct. 9 of last year that the case was finally resolved. O’Connor obtained $750 million in financing from a German bank, HSH Nordbank AG, and took over the project.

The sales office opened up immediately. O’Connor held a party on the roof of a newly built Manhattan club. And the outlook for future sales? One hundred thirteen potential buyers toured available apartments in one weekend alone, a fraction of the thousands who have walked the halls since October.

The divorce timeline

October 2005: Kalikow and O’Connor win bid for Manhattan House with $623 million offer.

Spring 2006: Several hundred Manhattan House tenants hire lawyer David Rozenholc to fight the Kalikow-O’Connor conversion plans.

May 2006: O’Connor complains to Kalikow for sending a “default letter” to Douglas Elliman without consulting him.

August 2006: Rozenholc
sends letter to the attorney general’s office requesting an
investigation into the conduct of the building’s owners and their
lenders, regarding their conversion plans.

November 2006: Martin
Burwick, 97, dies of pneumonia days after moving out of the Manhattan
House. Tenants blame his death on stress of eviction and unhealthy
conditions in the building during renovations.

January 2007:
company, Manchester Real Estate, terminates Exhale Spa, which was
brought on to run a gym and yoga center in the building. Manchester CFO
says Exhale was $50,000 over budget.

March 30, 2007:
Attorney general’s office approves the building’s $1.1 billion condo conversion plan.

April 5, 2007:
O’Connor sends Kalikow notice of intent to dissolve their
partnership. On the same day, the sales offering plan for the newly converted condo is mailed to all building tenants.

June 2007: State Supreme Court Justice Bernard J. Fried orders one partner to buy the other one out within 30 days.

August 1, 2007: Kalikow announces that O’Connor will purchase his interest.

Mid-August 2007: Kalikow seeks permission in court to amend the lawsuit to accuse Elliman of colluding with O’Connor and to seek damages.

October 2007: O’Connor
borrows $750 million from German bank HSH Nordbank AG to purchase
Kalikow’s stake in the building; he opens the sales office immediately.

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