In November 2014, after more than a decade of political disarray and public disappointment, the first World Trade Center tower finally opened, giving New Yorkers a sense that the sprawling commercial complex was becoming a reality once and for all. Things came more into focus this year, when the transit hub opened in March, followed by the topping out of 3 World Trade Center in late June.
And yet, a crucial piece of the development project — 2 World Trade Center— is still missing.
Just six months ago, Silverstein Properties was seeking to close on $2 billion in debt to construct the 2.8-million-square-foot, 1,270-foot-tall tower designed by Bjarke Ingels, when the developer was struck by a deal-killing blow: Its anchor-tenants-to-be, Rupert Murdoch’s 21st Century Fox and News Corp., announced in a joint letter that they were pulling out of their agreement to lease 1.3 million square feet on the lower levels of the building.
“We won’t start that building without some level of preleasing,” the firm’s CEO, Marty Burger, told The Real Deal. “We need either an anchor tenant or enough tenants to get to the preleasing level that will make lenders comfortable.”
It’s an improbable set of circumstances: One of the city’s most notable developers can’t get one of the city’s most well-known commercial office projects off the ground.
As lenders become all the more sensitive to which deals make sense on their books, both commercial and residential developers have become entangled in a game of survival of the fittest. The majority of banks and other financial firms have become increasingly selective about the kinds of projects they are willing to finance.
Because of that, the ability to successfully build a new condo or office tower typically depends on a confluence of circumstances involving generous amounts of equity and well-established reputations on the part of developers. In the case of office construction, there’s a rough formula for securing financing — one that includes a high demand for space, street-level retail and a hefty helping of recourse, which provides the lender with collateral in the event of nonpayment.
But even some of the most seasoned developers in the city are struggling to get the financing they need to complete these projects, especially when some banks are capping their exposure at $50 million.
“Then you have to get more than one bank together, and imagine trying to get 20 banks together to get to $1 billion when [each is] capped at $50 million.” said Julian Wise, a partner at the law firm Schulte Roth & Zabel.
Trophies lose their luster
Though Silverstein’s executives remain adamant that they will find a replacement tenant soon, the company’s predicament encapsulates the many challenges of building new large-scale office buildings in the city. In order to get the necessary construction financing for such projects, the sponsors behind them often need to show that up to 50 percent of the project’s rentable space is preleased, according to industry sources. Yet, on the whole, the appetite to finance new trophy office buildings is waning, with lenders more eager to fund the redevelopment of existing buildings. Gregg Gerken, head of the U.S. commercial lending group at TD Bank, said that very little spec office development is being done in New York right now and that developers are curbing risk for lenders by having their projects 35 to 50 percent preleased before beginning construction.
Silverstein’s Burger declined to specify what level of preleasing 2 World Trade Center would require before the company can continue building. Its previous anchor tenants, Fox and News Corp., had pledged to take nearly half the 2.8 million square feet of space.
Gerken said lenders will also look closely at the proposed project site’s submarket — such as Hudson Yards or the Financial District — usually studying Census data for job growth information and population levels, and market data for absorption rates to assure that a new office building is meeting an existing demand. Recourse also plays a dramatic role in financing new office buildings, he said, usually structured to cover myriad potential problems, like an incomplete project, fraud and mismanagement.
“We always prefer recourse,” Gerken said. “It’s a financial backstop for a project that is not preleased, for cost overruns, for design changes.”
Lenders are also wary of “an environment where there is a tremendous amount of regulatory oversight,” according to Wise. As a result, developers on commercial construction loans are required to “put some skin in the game,” he said. Namely, they must contribute at least 15 percent of a project’s estimated value. This is due to international banking reforms known as Basel III, which were implemented in 2011 to guard against “high volatility” real estate transactions. A “high-volatility” designation lasts through the life of a loan, a financial scarlet letter that sticks even if construction is completed before the loan’s maturity date.
As a case study of what kind of projects have been able to secure construction financing, WTC’s competition to the north, Hudson Yards, has managed to find tenants for its project 30 Hudson Yards. Related Companies and Oxford Properties Group in December secured $5 billion in construction financing from a group of banks and EB-5 investors well after the developers had an anchor tenant lined up for the building. The office building’s tenants include Wells Fargo, Nieman Marcus and Time Warner, the latter of which is taking 1.3 million square feet of the total 2.6 million square feet. When asked why Hudson Yards might have an advantage over 2 WTC, Gerken noted that including ground-floor retail is attractive to tenants and also to lenders, since owners can often charge tenants more for it than office. The project also benefits from a planned 960,000-square-foot residential tower, 15 Hudson Yards.
One exception to the preleasing rule is SL Green Realty Corp.’s proposed skyscraper One Vanderbilt on the corner of 42nd Street and Vanderbilt Avenue. The 1.6 million-square-foot office tower is expected to cost just north of $3 billion, and SL Green has said that it’s close to closing on a $1.5 billion construction loan before the end of the summer.
The company also plans to team up with a joint-venture partner, who will cover 50 percent of the required equity. The only announced tenant so far is TD Bank, which is taking 200,000 square feet in the building — or less than 13 percent of the available space. SL Green’s reputation is a help in its quest for financing: The REIT currently holds interest in 121 Manhattan buildings across 47.7 million square feet.
In addition to the company’s extensive portfolio, the tower’s proposed location gives it an edge. It’s a new office building in Midtown directly next to Grand Central Terminal, a quality that few buildings can boast. The building has been billed as a game changer for Midtown East, the first of more development to breathe life back into what was once a more vibrant commercial corridor. In May 2015, the City Council approved the first phase of a planned 73-block rezoning that will allow for taller buildings in the area. In exchange, developers are expected to improve public space and infrastructure. In 2014, SL Green unveiled plans for $210 million worth of improvements to Grand Central Terminal.
“To have a humongous new office building in Midtown is extremely rare,” said Mark Edelstein, chair of the real estate finance and distressed real estate practices at Morrison & Foerster. “I think that’s a building that will get built regardless and the tenants will come along the way.”
Much like with ground-up office development, it’s becoming an increasingly tough market for condo developers seeking construction loans — especially those developers that are new to the game. “If you’re a non-recognizable developer, you may have a better time winning the lotto than getting a loan from a commercial bank,” Edelstein said.
Many national and regional banks are shying away from financing luxury condos, leaving non-traditional lenders including hedge funds, EB-5 investors and a growing number of developers to fill the gap.
“To get a lender to do a condo financing now, you need to create a financing package that makes it almost impossible for them to say no to,” said Scott Singer, president of the Singer & Bassuk Organization, which arranges debt and equity financing on behalf of borrowers. “Lenders don’t want to stretch for condo deals. They’re not interested in helping neophyte developers take the next step.”
On the flip side, several sources pointed to Bank of the Ozarks as one of the few lenders to remain very active in financing ground-up condo construction deals. Woody Heller, executive managing director of Savills Studley’s capital transactions group, said that the Little Rock, Arkansas-based bank is currently the go-to lender for such projects. He noted that the bank isn’t cavalier about its underwriting choices but is likely benefiting from the fact that it has little competition in funding attractive projects. A representative for Bank of the Ozarks did not return requests for comment.
Bank of the Ozarks has recently been particularly busy in Lower Manhattan, where it provided a $64.8 million loan to Cape Advisors for its 23-unit condo building at 30 Warren Street and a $58.3 million loan for Madison Realty Capital’s 16-unit project in Noho, known as One Great Jones Alley. Many developers are pursuing condo projects that they think fill an underserved segment of the market, Heller said.
For example, in 2013, the City Council rezoned a section of Tribeca known as Hudson Square to pave the way for new residential construction. Heller said developers still view the neighborhood as fertile ground for condo projects. Bizzi & Partners Development, Halpern Real Estate Ventures and Aronov Development, the sponsors behind the proposed condo tower 100 Varick Street, secured a $320 million construction loan from Bank of China in January 2016.
“Is there a concern about oversupply at present? Generally speaking, there is,” Heller said. “But having said that, people are still trying to go forward with projects that they think address certain opportunities in the marketplace.”
Shying away from luxury
The diminished demand in the luxury market has impacted several seasoned condo developers like Steve Witkoff, who recently halted plans to convert his Park Lane Hotel into luxury condos. But toning down the “luxury level” of a condo project can help convince lenders that the project is worth building, according to industry sources.
Edelstein said that developers who pursue projects where the prices range from $1 million to $5 million may have an easier time getting financing than those that ask upwards of $2,000 a square foot.
In June, Alchemy Properties received a $67.8 million loan from M&T Bank for its 55-unit condominium at 50 West 30th Street. Alchemy’s president, Ken Horn, told TRD that lenders realize that the project is “priced well for the genre it’s in.” One-bedrooms in the building — called “Noma” — start at $1.4 million.
And Gary Barnett’s Extell Development recently cut $207.3 million from its sellout price for its massive One Manhattan Square, an 815-unit condominium tower rising at 252 South Street in Lower Manhattan. Prices for the condo units start at $1 million, to match the current demand in the market, Barnett told TRD at the time.
Earlier this year, the developer was seeking up to $200 million through the EB-5 program after landing a $463 million financing package in March from RXR Realty for three of his Manhattan projects, including the South Street tower. In exchange, RXR will get a preferred equity stake in the project, Bloomberg reported. The company had also reportedly been in talks for an $888 million construction loan from Deutsche Bank. But city records show that no additional loans from the bank have been provided since it offered a $150 million bridge loan on 252 South Street in July 2015. Barnett did not return a request for comment.
Some players in the condo market are actually welcoming a slowdown. During a panel on construction lending in May, RXR’s president and chief financial officer, Michael Maturo, said equity will continue to move condo projects, just at a more moderate pace. “I think that’s a good thing,” he said.
Similarly, Robin Schniederman, director of new business development for Halstead Property, said that the retreat of lenders will provide a much-needed correction in the condo construction market.
“If the construction financing market dries up, I think it’s actually going to benefit the New York City condo market. It will actually start reducing the number of new condos in our pipeline,” he said. “With fewer deals, this is ultimately going to be a positive trend. The last thing you want is where we’re flooded with inventory.”