Guarding the green

As the commercial credit crisis kicks into high gear in the New York market, SL Green, the city’s largest commercial landlord, has found itself in the center of a growing storm.

The publicly traded investment trust, which owns 29 office buildings in Manhattan alone, is facing the sudden reality of holding billions of dollars in commercial debt in a real estate market that is rapidly declining.

After years of making highly leveraged deals, led by the mammoth $6 billion acquisition of rival real estate investment trust Reckson Associates in 2007, the company is now awash in a sea of debt.

What’s worse, it’s on a ship that is leaking revenue in the form of dropping commercial rents.

“There’s been an overall repricing of space in Manhattan that started in the fourth quarter of last year and really picked up steam through March of this year,” said the company’s executive vice president of leasing, Steve Durels.

Also, because of the tenant mix in its buildings (Citigroup alone occupies 13 percent of SL Green’s commercial space), the firm is heavily exposed to investment banks and hedge funds that are reeling from the 2008 stock market collapse.

The weak office leasing market is not the only challenge facing the company.

Last month, SL Green and Aqueduct Development Partners filed suit in New York State Supreme Court against Buffalo, N.Y.-based Delaware North Companies, alleging that the firm sabotaged their efforts to operate video lottery terminals at the Aqueduct Raceway in Queens.

In 2008, SL Green and Hard Rock International (of Hard Rock Café fame) were outbid by Delaware North on a bid to redevelop the ailing racetrack into a hotel casino complex, featuring lucrative slot terminals. The suit alleges that Delaware North used proprietary information from an earlier relationship with SL Green to submit the winning $370 million proposal, which later fell apart due to the credit crunch.

Delaware North president William Bissett blasted the suit as a “desperate attempt by SL Green to enhance their standing in the re-bid process.”

If SL Green is showing signs of desperation, it’s likely due to decisions it made during New York’s real estate boom.

In 2006 and 2007, the company became one of the industry’s most aggressive buyers of trophy assets, including the purchase of Reckson, which netted it high-profile properties like 810 Seventh Avenue, 919 Third Avenue and 1185 Avenue of the Americas, among others.

The deal also came with $2 billion in debt.

In one of its last major deals of 2007, SL Green joined in the $1.57 billion purchase of 388 and 390 Greenwich from Citigroup, which leased back the space in full.

But some say the fate of those deals is now being seen in the precipitous drop in SL Green’s stock price, which has plunged more than 80 percent from its 52-week high of $101.07 in June 2008. At the end of last month the stock price was roughly $19.

Stifel, Nicolaus & Co. analyst John Guinee also downgraded SL Green’s stock to “sell” from “buy” late last month, citing an “unappealing” risk-to-return ratio. He said he was concerned about the high amount of leverage the company has in this environment.

Meanwhile, in a fourth-quarter conference call, SL Green’s CEO Marc Holliday warned the company would have to watch out for the possibility of business failures or bankruptcies among its tenants over the next year or two. Holliday pointed out that there was a “notable increase in delinquencies and bankruptcy filings” into January.

“I think we will have to expect that one of the risks we will have to guard against, and be very proactive on, is monitoring our tenants carefully, making deals where appropriate, not making deals where appropriate and looking to switch our tenants early who we think will pose the greatest risks to our portfolio,” he told investors.

Holliday noted that SL Green had already signed advance leases for 1.6 million square feet of office space set to expire in 2009 and 2010, leaving only 800,000 square feet of unsigned spaced set to expire in 2009. He said the company, which has a total of $5.7 billion in debt, expected to renew most of that space.

Industry watchers are, however, concerned that continued job losses will prompt Citigroup and its fellow banks to default on leases, unload even more space on the sublease market or — at best — demand significant new concessions and lower rents.

Durels also acknowledged the exposure the company has, but claimed that the quality credit of its largest tenants will limit overall risk of default.

“We’ve got a significant exposure [to financial companies], but when you whittle it through, the vast majority of our tenants, the government has deemed them too big to fail,” said Durels, citing Citigroup, Credit Suisse, Credit Lyonnais and Morgan Stanley. “Hedge funds, as a percentage of overall revenue, are in the single digits.”

Short-term concerns

By late 2008, the biggest short-term concern at SL Green was the fate of 1515 Broadway.

The building, which is in the heart of Times Square, had a combination of short-term CMBS debt coming due, and a high-profile anchor tenant — Viacom, the media conglomerate — that was openly shopping for cheaper space in a new location.

SL Green bought the building in 2004 for $480 million, and recently invested another $160 million upgrading it. Improvements included a new façade, new lobby, and other upgrades undertaken with an eye to getting silver LEED certification.

The company took out a $425 million floating-rate loan from Wachovia and Lehman Brothers that was scheduled to come due in 2007. But according to the Manhattan-based research firm Trepp, the company has since exercised two of three extensions.

Asking prices at the building were $85 a square foot. But Viacom was paying an average of about $52 per square foot for its 1.3 million square feet. After months of furious negotiations near the end of 2008, Viacom agreed to remain at the building through 2015, with an option to extend the lease. On a conference call late last month, SL Green executives said Viacom was given four months free rent to sweeten the deal.

SL Green, meanwhile, is marketing the remaining 132,000 square feet of space in the building at asking prices ranging from $58 to $70 a square foot.

But marketing space in this climate is not an enviable job.

Data from the first quarter show that commercial office rents across the city are taking a major hit because of the weakness in the financial industry. And as a major player on the commercial scene, there seem to be few options for SL Green to escape that reality.

“The Manhattan office market continues to experience anemic levels of leasing and an abundance of available sublease space, which has led to unprecedented declines in rental rates,’ Cushman & Wakefield stated in its first-quarter market report.

The report pointed to March, typically the strongest leasing month of the year in Manhattan, as an example of how severe the leasing situation has gotten. For the last six years, an average of 2.39 million square feet of space was leased during that month; however, this year, only 934,000 square feet was leased — a 60 percent decline.

Meanwhile, average Midtown Class A rents are now down 15.3 percent from their peak, to $79.13 a square foot, while overall Class A rents are down 14.9 percent from their September 2008 peak of $57.70.

Eric Anton, executive managing director at Eastern Consolidated, argued that SL Green might be somewhat more sheltered from those forces, because unlike many other commercial landlords, the company does not rely on outside brokers to manage its own lease negotiations.

Anton said that the arrangement gives the firm a better feel for what’s going on at every individual property. “Because they do everything in-house, they make it easier for guys like me to sell real estate to them and for them,’ said Anton. “They keep very tight control of their properties.’

Marc Hughes, chief financial officer at SL Green, said the company has an average in-place rent of $53.59 a square foot, but noted that only 14 percent of its Manhattan portfolio is expected to turn over during the next three years, which means the company will have relatively less exposure to losing tenants than some other commercial landlords.

And SL Green’s Durels claims that leasing activity has been “dramatically increasing’ since early January. In recent weeks, SL Green has renewed or signed several leases at key properties.

Durels said that Insight Communications, a Manhattan-based cable television firm, just renewed a 35,000-square-foot lease at 810 Seventh Avenue, where asking rents range from $58 to $65 a square foot. The terms of Insight’s lease were unavailable.

And just last month, First Wall Street Group signed a 15,945-square-foot lease at 100 Park Avenue, where SL Green has completed a $72 million renovation.

In addition, Wells Fargo Trade Capital Services, which signed a 44,716-square-foot lease in January, agreed last month to take another 12,293 square feet of space in the same building, where asking rents range from $65 to $80 a square foot.

SL Green still lists more than 200,000 square feet of space at the building on its Web site.

In recent months, SL Green has taken steps to unload some of its debt overhang by selling assets. In December, for example, the company and its corporate finance arm, Gramercy Capital Corp., agreed to sell their interest in 55 Corporate Drive, a 670,000-square-foot office building in Bridgewater, N.J.

The $230 million deal included the assumption of a $190 million mortgage and marked the first of several potential asset sales by SL Green.

SL Green has also been in discussions on a deal to sell 485 Lexington Avenue to Murray Hill Properties, but talks have reportedly stalled while Murray Hill looks for an investment partner. SL Green bought the property, and the adjacent 750 Third Avenue, for $480 million in 2004.

Carl Schwartz, a partner at Herrick Feinstein, which has represented SL Green on several key deals, said the company would consider selling additional properties, but would only consider solid offers.

“If they wanted to dump assets, they would be on the marketplace with a lot more aggressiveness than they have been,’ he said. “I think they will entertain reasonable offers.

“The idea that there are fire sales happening? I don’t think that will be the case.’

And late last month in a conference call, SL Green officials acknowledged that the company has entertained offers for some of its New York assets. But they noted that the capital markets here remain “gridlocked.’

Meanwhile, the company, which actually saw a 3.9 percent increase in revenue in the first quarter of 2009 compared to the same time in 2008, has taken steps to reduce expenses. It cut $50 million from its 2009 budget, mostly through negotiating lower costs from contractors and taking advantage of declining labor and building material costs. The company cut another $5 million in management, general and administrative expenses by reducing head count, lowering compensation levels and cutting some accounting expenses. And it announced an energy conservation program that it says will cut steam usage an average of 10 percent at 13 properties, including 100 Park Avenue.

Still, Manhattan-based real estate attorney Ed Mermelstein says the declining market spells trouble for many of the city’s biggest landlords, including SL Green, because loans are coming due on properties at a time when rents are dropping and tenants are imploding.

“Many of these major landowners are either going to face sales of the properties, bankruptcies or a combination of both,’ he said. “There’s really no way around that. Anyone who’s in an overleveraged position and either has loans coming up or can’t make [their] overhead short-term [costs] are in a situation where they are defaulting.’