Hedge funds are the hottest commodity in the investment business, but the boom in these high-end finance shops has New York commercial brokers adjusting to a new type of tenant.
The proliferation of new hedge funds represents a lucrative clientele, but structuring leases for a host of new businesses with short track records is prompting more than a few nervous recollections of the dotcom wave that swept away leases in the bust of 2000.
Because a hedge fund’s assets are its investors’ money, rather than tangible assets, security for a lease is sometimes a tricky proposition, says Michael Kaufman, managing director of the Kaufman Organization, which has acted for hedge fund tenants and landlords.
In a big-money business, hedge fund managers can demand elegant boutique offices, and ask landlords to make large cash contributions to build out space.
Commercial brokers have had to devise various strategies for handling hedge fund clients, who have saturated the leasing market over the past two years. A principal hurdle is psychological, as brokers must convince landlords that hedge funds are not this century’s dot-com.
“Granted, these are very smart people these are not fly-by-night operations,”
Kaufman said. “But hedge funds are a trend, and the last trend was the dot-coms.” Kaufman has found the best way to appease landlords is having the hedge fund put down larger security deposits up front anywhere from six to eight months’ rent. For larger security deposits, a tactic called a “burn down” can be used, meaning as the fund complies with the lease terms, the landlord will return portions of the security deposit.
Peter Sabesan, a partner at Hunter Realty, which represents hedge fund tenants, said managers are generally very private, declining to reveal their financial statements or even the names of their principals. A burn down can be a good tactic with a reticent but deep-pocketed tenant.
“If hedge funds don’t want to give up financials, you negotiate a security deposit, and you do a burn-off after a couple of years,” Sabesan said.
Eric Reimer, senior vice president at Trammell Crow Company, who often consults with hedge funds seeking space, uses a letter of credit from a bank as a substitute for a financial track record for young hedge funds.
“Hedge funds just generally have the bank put up a letter of credit reflecting a portion of the rent, reflecting a portion of the free rent, and reflecting a portion of the commission,” Reimer said.
But for more mature hedge funds with track records, this is not as much of an issue, he said.
Still, security deposits can be a bone of contention between hedge fund tenants and potential landlords, because the financial entity signing the lease often has very little actual money of its own, said Benjamin Friedland, a vice president at CB Richard Ellis. He said many hedge fund principals are typically wealthy individuals who believe their backing should compensate for this lack of liquidity.
Some brokers employ what is known as a “good guy guarantee.”
“This means that the principals are personally liable should the tenant default and not get out of the space,” Friedland said. That can give a landlord a comfort level beyond a security deposit, he added.
Another strategy is an assets under management test, Friedland said. A landlord might offer a standard security deposit deal, but will continue to scrutinize the fund’s assets under management. If they fall below a certain level, the hedge fund has to post additional security. Kaufman said both hedge funds and landlords might have reservations about this strategy.
“I’ve heard of this, but I don’t know anyone who’s used it,” he said. “The problem is getting the customer to agree to that arrangement, and from a landlord’s point of view, it becomes a big headache to review all that paperwork.”
The best way to make these deals work, however, remains the old boy network.
At more established funds, the principals tend to have friends at the top end of the real estate business, said Adam Goldenberg, a broker with Cushman & Wakefield who represents hedge fund tenants.
“Sometimes a landlord has money invested in them,” he said, “they went to business school together; they worked at Goldman Sachs together. A lot of those deals get done principal-to-principal.”
At larger brokerages, commercial agents can often close leasing deals before available space is even publicized.
“It’s a small universe of people that tend to operate in a handful of buildings that tend to attract that type of tenant seeking that installation of space,” Goldenberg said, “so we’ve been involved in a number of transactions where the space never hits the market.”
Hedge funds and Midtown offices get cozy
The 1930s bandit Willie Sutton said he robbed banks because that’s where the money was, and those words apply equally well to hedge funds’ choices for office space.
In the Midtown environs favored by these high-finance flyers, many landlords seek out hedge funds and other tenants who are looking for elegant boutique spaces of 3,500 to 5,000 square feet, costing anywhere from $40 to $80 a square foot.
Brokers say some of the popular buildings among hedge funds are 450 Park, 399 Park, 527 Madison, 540 Madison, 535 Madison, 520 Madison, 717 Fifth, 712 Fifth, 767 Fifth, Carnegie Hall Tower, and the Seagram Building at 375 Park. The combination of cachet and access keeps a landlord’s tenant list tony, and provides the right setting for attracting new investors to these funds.
Some landlords will pre-build their space to accommodate hedge funds, which generally seek a classy reception area, two meeting rooms, a copy/fax room with ample storage, and a bullpen area for traders surrounded by large offices for principals. Landlords can reap benefits from that investment later on as hedge funds grow and attract other hedge fund tenants.
Landlords who don’t actively seek hedge fund tenants can find unexpected benefits in leasing to the financial dynamos. Often hedge funds will spend much of their own money finishing out spaces.
“Typically, they pay high rents and do elaborate installations at their own expense,” said John Farrell, a broker with Helmsley-Spear, Inc. “With the right security, the risk factor [for landlords] is actually low.”