As the bottom begins to drop out of the Manhattan office market, the most compelling series of negotiations will not necessarily be between commercial landlords and their tenants, but between those landlords and their lenders.
The record boom in real estate was based in part on a run-up in rents that some critics say was more about prestige than true market value. But now, the collapse of the financial services business and the ensuing economic woes means that trophy towers from the Plaza District to Lower Manhattan may suffer from a prolonged slump in rental income.
As a result, building owners will probably face tough sledding to satisfy their
lenders.
“There were some very aggressive deals done that are going to be problematic,” said Matthew Anderson, principal of Foresight Analytics, an Oakland, Calif.-based market research firm.
Industry experts say landlords will be under considerable pressure to maintain their existing asking rents, but with tenants having a lot more negotiating leverage in the current market, lenders may need to extend a lifeline to their customers.
Scott Singer, executive vice president at the Singer & Bassuk Organization, which brokers financing for real estate firms, said that commercial leases commonly include language that allows the landlord to “rent on market terms.” Therefore, if the market is down, the landlord has the right to rent at whatever the market rates are.
The tipping point comes when the
rents that a building pulls in are not high enough to pay off its debt service. In that case, the challenge is expected to be in
determining who makes the decision on whether to ride out the storm or to call in a particular investment.
Calling in investments
In the current market, loans are often
sliced up into little pieces and redistributed among multiple groups of investors. Therefore, a commercial landlord is often forced to deal with several layers of red tape before a decision is made on whether to grant a loan extension or refinancing, or to call in a default.
“In certain cases, banks are willing to talk, but they’ve sold off pieces of the loan to institutions that aren’t willing to talk,” said attorney Ed Mermelstein. “There are so many players involved in each of these loans that no one can agree.”
In addition, many commercial loans are not administered by the original lender,
but by third-party banks whose sole responsibility is to manage the performance of
the investment.
“A lot of the lenders no longer hold those loans; they seem to be in the hands of a special servicer,” said David Csontos, senior vice president in the investment sales division at GVA Williams. “They are serving at the behest of the bondholders.
“At some point in time, somebody is going to have to step up and say, ‘Foreclosure is the right thing,'” he said.
One building that’s already been affected by the market downturn is 620 Sixth Avenue in Chelsea, which was acquired in 2005 for $287 million by a group of top Manhattan real estate investors, including Yair Levy, Joe Chetrit and Charles Dayan.
Sources say the mezzanine debt was put up for sale in recent weeks after the owners failed to turn over enough leases to higher-paying tenants and decided not to expand the building, which had 200,000 square feet of air rights that could have been developed into condominiums or additional office space.
The landmark 670,000-square-foot building was appealing to the investors because it is one of the top retail sites in the area. In addition to Filene’s Basement and Bed Bath & Beyond stores, it has office
tenants that include Nike, the Gap and
Yahoo!
The owners attempted to raise rents by more than 50 percent, up to about $65 a square foot. And while designer Cole Haan recently expanded its existing lease by 28,000 square feet, the building has more than 70,000 square feet of vacant office space on its top floor. “That’s an example of a fabulous building that was acquired with too much debt,” a source said.
Officials at Newmark Knight Frank, which is leasing the space, and at the Chetrit Group were not available for comment.
Rental incomes reel
Few commercial landlords face more near-term exposure than Broadway Partners. The New York-based firm went on a spending rampage over the past seven years, acquiring about $14 billion in commercial real estate nationwide.
As part of its shopping spree, the firm has engaged in a number of highly leveraged acquisitions that were financed with short-term debt and based on fairly steep projections of rental income, including several high-profile deals in New York.
In June 2007, it bought 450 West 33rd Street, a 1.6 million-square-foot office building on the far West Side, for nearly $700 million. The firm put the building up for sale in early 2008, but a deal failed to materialize. As first reported by the New York Times, a new report by research firm Real Capital Analytics lists the tower as a troubled asset that is in danger of failing.
The building has been home to the New York Daily News, the Associated Press and other media and publishing companies.
Prior to the deal, asking rents had been in the low $40s. However, the Hudson Yards area had been expected to undergo massive commercial and residential growth. Now, with the economic crisis ravaging real estate development, nearly all major projects in the area have been halted.
Broadway Partners officials were not available for comment.
The firm’s other highly leveraged deals include the 2006 acquisition of 340 Madison for $550 million, the 2007 acquisition of 280 Park Avenue and the acquisition of the Beacon Capital Portfolio, which included the Park Avenue Atrium, at 237 Park Avenue.
Park Avenue Atrium took a hit from the collapse of Bear Stearns, which in 2007 expanded an existing lease to 250,000 square feet. Cushman & Wakefield now lists more than 166,000 square feet of sublease space in the building, but has not listed an asking rent.
And Broadway Partners has since started a series of deals to deleverage its assets, including the sale of 340 Madison Avenue, but it has $900 million in short-term debt coming due this month.
Meanwhile, Boston Properties, the real estate investment trust led by Mortimer Zuckerman, got an early taste of the financial crisis when Lehman Brothers, one of its largest tenants, collapsed.
In addition, the 118-year-old law firm of Heller Ehrman shut down in September, exposing 144,000 square feet of space at 7 Times Square, where Boston Properties is the landlord.
Doug Linde, president, speaking on a third-quarter conference call with Wall Street analysts, noted that the company received $43 million in annual rent income from Lehman Brothers, which leased 436,000 square feet at 399 Park Avenue, which the company now expects will be vacant through 2010.
The firm also receives $57 million from 48 different hedge funds and $77 million in rent from Citibank, which is shedding space at the Citigroup Center, where rents are expected to drop from $170 to $140 per square foot asking prices. Bloomberg News reported that the company plans to drop the Citigroup name at the building and rename it 601 Lexington Avenue.
“These events clearly came as a shock to us, and it made it clear at the moment that you can’t take anything for granted, and no organization is immune from significant disruption,” Linde said.
After buying the GM Building for $2.8 billion in June, Boston Properties insists that it has very little short-term exposure, noting there is very little space that is up for renewal in the near term; the few leases coming due are priced at half the market rate.
The company says that rents in the building are going for $140 to $200 a square foot.
Nonetheless, developers warn that loans should have a built-in allowance for an economic downturn, because rents cannot continue to rise without end. “The smart landlords see the writing on the wall,” said James Wacht, president of Sierra Realty Corp. “People who bought buildings in the last two or three years, who may have large mortgages, they may not be able to rent space at a rent that’s the market rent.”
However, Steve Kohn, president of Cushman & Wakefield Sonnenblick Goldman, said that landlords were largely justified in what they paid because the indications were that the market was resilient.
“It’s not fair for anyone to look back now and say they shouldn’t have paid what they paid,” said Kohn, whose firm arranges financing for commercial and multifamily buildings. “To be absolutely perfect all the time [is something] we wish we could be.”