Several financing offshoots of major real estate companies have hit the skids, burdened by soured loans and investments and a limited access to capital as the financial crisis has intensified.
These companies include Gramercy Capital Corp., which grew out of SL Green Realty Corp.; Centerline Holding Co., a creature of the Related Companies.; Chimera Investment Corp., created by Annaly Capital Management; and iStar Financial, a child of Starwood Capital Group.
All but Centerline are real estate investment trusts (REITs) and are headquartered in Manhattan.
The spinoffs were formed to exploit opportunities in various corners of commercial and residential real estate when times were good. But the credit crunch has thrown them for a loop.
The companies all have similar missions in different sectors of the market: Gramercy Capital finances commercial real estate transactions. Centerline lends to owners and developers in the office, retail and multifamily sectors. Chimera is in the residential arena, investing in mortgage securities and loans. And iStar makes loans to commercial real estate developers and investors, usually in amounts of $20 million to $150 million.
However, experts note that the financial crisis has destroyed the business model for commercial real estate finance companies. Under the usual model, the companies borrow money over the short term to make investments over the long term. Obviously, investment returns have to exceed borrowing rates for the companies to earn profits, and that’s not happening now.
“My impression is that they were essentially playing the yield curve, and that’s a tricky business now,” says Barry Vinocur, editor of the newsletter REIT Wrap.
Gramercy Capital
SL Green externally manages Gramercy Capital, which it took public in 2004. The larger firm remains the company’s biggest shareholder, with a stake of about 15 percent.
The credit crisis has taken a stiff toll on Gramercy. Its net income tumbled to $9.66 million in the third quarter, from $97.15 million in the year earlier, thanks to bulging loan losses and interest expense. As a result, the company halted its dividend.
SL Green had counted on fees and income from Gramercy for part of its own profit, and Gramercy’s woes have taken a toll on its parent. Now, the two firms have begun to separate.
Until October, SL Green’s chief executive Marc Holliday had been Gramercy’s CEO too. Bu, now, the spinoff has its own CEO, Roger Cozzi. In addition, Gramercy has cut the fees it will pay SL Green through 2009, when the management agreement between the two companies ends.
Still, worries about Gramercy’s loans and its access to credit dog the company, as the credit crisis creates more defaults and makes it harder for Gramercy to borrow money. According to the Wall Street Journal, the firm is close to breaking covenants on some of its credit lines.
The company’s reliance on collateralized debt obligations to finance its activities represents a problem too, as that market is virtually closed.
“That’s why Gramercy bought American Financial Realty this year — to get out of loans and into the net leasing business,” says a New York real estate analyst who requested anonymity. Gramercy paid $3.3 billion to acquire AFR, which owned 1,300 commercial buildings.
The stock market has reacted negatively: Gramercy’s stock price plunged 95 percent to 88 cents as of Nov. 17 from $19.35 a year earlier.
As for SL Green, strong leasing activity at its Manhattan properties helped compensate for Gramercy’s woes in the third quarter, when funds from operations totaled $88 million, up from $77.8 million in the year-earlier period. SL Green and Gramercy declined to comment.
Centerline Holding
Centerline originates loans and invests in bonds backed by commercial mortgages. It grew out of an affordable housing unit that began as part of Related. The unit was turned into a separate company — CharterMac — in 1997 and was renamed Centerline in 2006.
Related, which has dozens of New York City projects and was selected to develop the Hudson Yards site on Manhattan’s West Side, retains a 13 percent stake in Centerline. In addition, Related’s CEO Stephen Ross is Centerline’s chairman.
Centerline has been hammered as the financial meltdown has inhibited its borrowing ability, and commercial real estate transactions have dried up. The company posted a net loss of $157.3 million in the third quarter, swinging from a profit of $9.45 million in the year earlier. And its stock price has plummeted 98 percent over the last year, to 27 cents.
Charge-offs, or debt determined by a creditor to be uncollectible, have stung Centerline. In November, Centerline announced it was trimming its staff by 20 percent, or about 100 workers.
The previous month, the company had agreed to reduce its term-loan debt to no more than $50 million by Nov. 21, which would entail a payment of about $18.8 million. That move led Moody’s and Fitch to downgrade Centerline’s debt ratings.
It must repay the remaining $50 million by Dec. 31.
Fitch said its downgrade “reflects the adverse impact of current market conditions on Centerline’s business franchise and financial condition.”
On Oct. 30, the New York Stock Exchange announced that Centerline fell through one of the exchange’s listing requirements because its market capitalization amounted to less than $75 million and its last reported shareholders equity totaled less than $75 million. Centerline declined to comment.
Chimera Investment
Chimera may be the newest spinoff of the bunch. Annaly, a New York–based REIT that invests in residential mortgage securities, formed the company last year as a complement to its own operations and bought 10 percent of Chimera’s shares at the initial public offering.
Annaly acquires only agency mortgage securities — those guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. Chimera, by contrast, invests in non-agency mortgage-backed securities and home mortgage loans.
“Chimera is a more credit-sensitive mortgage REIT, while Annaly doesn’t take credit risk,” explains Steven Delaney, an analyst who follows the company for JMP Securities in Atlanta. “There is nothing Chimera does that Annaly couldn’t have done. But that would have soiled the purity of Annaly’s portfolio.”
Also, Annaly’s Fixed Income Discount Advisory Company (FIDAC) is Chimera’s investment manager. By creating Chimera, Annaly was creating a new asset management client that could generate fee revenue for its FIDAC subsidiary.
Of course, Chimera picked a bad time to debut, purchasing its initial portfolio in late 2007 and early 2008. Non-agency mortgage securities have plunged in value since then.
“The assets they invested in have lost market value, though they have performed well in a credit sense,” Delaney says.
Chimera hoped to use modest leverage, but the credit crunch has killed that idea, so the company has had to shrink.
“The combination of that shrinkage and declining market values has caused a loss of book value,” Delaney notes.
To refill its coffers, Chimera raised about $274 million in a secondary stock offering during October, with about $26 million of that stock bought by Annaly.
“Now they are back in business, and will invest in mortgage assets at a much lower price and on an unleveraged basis,” Delaney says. “So it has good prospects ahead.”
Chimera and Annaly both declined to comment.
IStar, meanwhile, began in 1993 as part of Starwood Capital, the company that recapitalized the Starwood Hotels, known for the Westin and W brands. IStar chief executive Jay Sugarman came up with the idea for the company, which went public as an REIT in 1998 and is now independent of Starwood.
IStar got itself into trouble with the $1.9 billion purchase of Fremont General’s commercial-mortgage portfolio and lending business last year.
That deal gave iStar a heavy exposure to the troubled condo market. As part of the transaction, iStar took Fremont’s $6.3 billion commercial real estate loan portfolio, made up largely of condo loans. IStar also had to finance Fremont’s commitments to $3.7 billion of loans, many to unfinished condo projects.
The firm is now desperately trying to sublet 107,000 square feet of space at 1095 Avenue of the Americas (see Tenants say ‘see you later’).
In September, Moody’s cut iStar’s debt rating to junk. The move was quite damaging for a company that finances its lending to real estate developers and investors by borrowing in the credit markets.
Moody’s made the move because it expects the company’s “asset performance will experience further pressure” amid weakness in the commercial real estate market. Moody’s noted in a report that it expects iStar’s nonperforming assets to exceed 8 percent of its total assets as iStar’s borrowers have trouble paying back loans.
IStar officials would only say that while the rating on the firm’s debt was lowered, the company was still left with an investment-grade rating.
With loan losses and asset impairments, iStar registered a net loss of $305.8 million in the third quarter, swinging from a profit of $93 million in the year-earlier period. The company has halted its dividend. “With more debt obligations coming due in the spring, iStar is hanging on to whatever cash it has to survive, though we still believe the forecast looks dreary,” Morningstar analyst Nicholas Cavallaro wrote in a research note.
And what is the broader outlook for these firms — iStar, Centerline, Gramercy Capital and Chimera —going forward? “Bad,” says the anonymous New York analyst. “First you have to get through the current liquidity crisis, and then you have to see if you really have a workable business model. Did you pick good loans and investments?”