Scott Lawlor once told a reporter he measured the success of his firm Broadway Partners largely on its ability to find new assets. Today, the survival of his firm depends on its ability to sell them.
With hundreds of millions of dollars in short-term debt coming due in January, Lawlor’s private equity firm has emerged as the latest poster child for overleveraged post-boom distress. Now that Harry Macklowe’s goose has been cooked, it’s Broadway’s nationwide effort to unload trophy office towers that has become the real estate saga du jour.
“They came out of nowhere, buying up all these deals and reselling them,” crowed one rival investor, who asked not to be identified. “Now, they’re in deep shit.”
Lawlor’s spokesperson said he is not talking to the media. Associates said he has felt stung by negative press coverage.
“The media has pretty much beaten them to death recently,” said one, who also asked not to be named.
Certainly, there’s plenty to write about. Between May 2006 and May 2007, Broadway snapped up more real estate in Manhattan than all but two buyers — Macklowe and Tishman Speyer, according to a June 2007 survey compiled by The Real Deal.
Those buys included $1.25 billion for 1.2 million square feet at 280 Park Avenue and $644 million for 1.7 million square feet at 450 West 33rd Street, among other properties. The firm also bought trophy properties in Boston, Los Angeles, San Francisco and Washington, D.C., among other cities.
To finance its spending spree, however, Broadway borrowed heavily, with short-term debt and risky adjustable-rate loans, the repayment of which was predicated on expected future rent increases. With the credit markets frozen, and the commercial markets deteriorating, Broadway now finds itself unable to refinance its loans to meet the first of what are likely several rolling debt deadlines. About $900 million in short-term debt comes due in January, sources said.
Broadway a bellwether
Broadway’s scramble to unload high-profile properties that it bid aggressively for has made the company a natural subject of media scrutiny. But they are certainly not the only firm in a bind.
Indeed, Broadway’s fate is being closely watched for what it portends for the market as a whole. The company’s primary lender, Lehman Brothers, has already gone under, in large part because of its fast and loose lending standards during the boom years. The New York Times recently referred to Lehman as a “real estate ATM.”
There are also troubling signs that the fallout from the frozen credit markets and deteriorating commercial markets is only beginning. In a report issued Sept. 26, Real Capital Analytics warned that “distressed sales are rising at an alarming pace,” noting that about 17 percent of recent commercial sales volume could be “tied to sellers known to be distressed.”
Still, Broadway’s story is certainly one of the most dramatic in recent times. And its progression is likely to continue to fascinate industry insiders for months to come.
Founded in just 2000, Broadway’s emergence as a major player coincided with the boom in loose lending standards and easy credit. The firm’s rise was meteoric.
Lawlor, a 43-year-old graduate of Columbia University’s School of Architecture, cut his teeth at Fortress Investment Group, a real estate investment firm with a longer record of success.
After starting out small (partnering on a $4.8 million purchase of an old school building in Hartsdale, New York), Lawlor and his team quickly excelled not only at winning big bids, but also at flipping trophy towers for a hefty profit — and trading up to the next buy.
In 2003, Broadway moved its offices from Greenwich, Conn., to the Seagram Building on Park Avenue, the domain of finance titans. Meanwhile, the company bulked up with institutional capital from sources like state pension funds, and used leverage to supersize.
From 2002 to 2007, the firm purchased more than $13.6 billion worth of office towers, reselling a number of them for handsome profits. The company bought Washington Harbor, a 537,000-square-foot office retail and condo complex in Georgetown, for $185 million in March 2003, then resold it to Prudential Real Estate Investors for $220 million. In 2006, Broadway bought 660 Madison for $215 million and sold it a year later for $375 million.
The approach won Lawlor a reputation as a “flipper” and engendered some resentment among competitors, who complained his risky behavior helped drive bids into the stratosphere and wasn’t sustainable. Still, it worked in the short term. In 2006, Lawlor boasted of returns averaging more than 38 percent.
“We have a very strict discipline we try to bring to bear about sales,” Lawlor told the New York Times that year. “We never track assets under management as a measurement of growth. It’s, ‘How are we performing, and are we continuing to find new assets?'”
But that was before the credit markets seized up. Or, as a number of industry players put it, that was before “the music stopped, leaving Broadway without a seat” — and holding more office towers than a medium-sized city and more short-term debt than many small nations.
Playing for time
Earlier this year, Broadway paid a fee to extend a deadline for its first wave of short-term mezzanine loans: About $900 million is now slated for repayment in January. An additional $300 to $400 million is due next spring, according to sources with knowledge of the firm’s situation.
But that may be just the tip of the iceberg. Between December 2006 and May 2007, the company purchased more than $8 billion of properties, including Boston’s iconic John Hancock Tower and three towers in New York: 100 Wall Street, 450 West 33rd Street and 237 Park Avenue. Much of that spending is also thought to have been financed with short-term debt that will soon come due.
Lawlor and his staff have taken a number of different actions in recent months to stave off calamity, including pursuing venture partners to help refinance specific properties such as the Hancock building. Also, last spring, the company laid off a dozen marketing and research staffers and shut down its Paris office. But the firm’s core survival strategy has been an aggressive “disposition program” to raise capital.
Initially, Lawlor and Broadway hit a major wall, which only fed the negative chatter. They had hoped to raise the funds by unloading pricey New York real estate, but abandoned those efforts after they reportedly couldn’t get the prices they wanted.
Even so, prior to the turbulent events last month, including the bankruptcy on Sept. 15 of the firm’s largest lender, Lehman Brothers, Broadway seemed well on the way to raising enough cash to meet its first deadlines.
The company found buyers for five buildings (in Boston, Houston, Los Angeles, San Francisco and Washington, D.C.), with prices totaling $1.13 billion, which would have allowed Broadway to pay creditors through next spring, at the very least. But some of those deals have yet to close, and it’s unclear what impact the market turmoil is having on those plans.
The most significant deal — to sell a 43-story office tower for $370 million to a Korean asset management fund — reportedly remains up in the air, even though the agreement to buy the property took place way back in May.
“I think you can infer that without the sales they were able to pull off, they would be in much more serious trouble,” said one industry source who has worked with the firm. “And given the events of last week, I think all bets are off for them and others like them.”
A crush of sellers?
Whatever the outcome, Broadway’s struggles — like Macklowe’s fall from grace — have implications that resonate far beyond the conference rooms of its tony Seagram Building headquarters.
Like Kent Swig’s Swig Equities and Mort Zuckerman’s Boston Properties, Broadway’s acquisition strategy has been focused on trophy buildings in big cities — desirable properties won through competitive bids, properties that many covet. It’s a strategy that may help the firm raise capital, but other overleveraged investors may not be so lucky.
And plenty of those are likely to face similar struggles in the months ahead.
“A lot of people took short- to mid-term loans, and a lot of people took as much as they could,” said Robert Knakal, chairman and founding partner at Massey Knakal. “It was a low rate, it was easy and it was tempting.
“This is going to be a very significant issue over the next two years. There’s going to be a significant deleveraging of the market,” Knakal said.
The default rate for commercial loans is 0.4 percent, and he expects it to increase further over the next 12 months.
Even more ominously, the number of owners selling buildings to stave off creditors or plug financial holes is beginning to spike. Among them: Risanamento, the Italian firm that bought 660 Madison from Broadway, saw its share price fall 80 percent last year and is reportedly under pressure to liquidate assets including 660 Madison, probably at a much reduced price.
“The level of distress is increasing rapidly and is much higher than mortgage delinquency levels,” the Real Capital Analytics report dated Sept. 26 warned. “In addition, it signals that pressure on sellers is mounting, even for those not yet in distress.”
That pressure is likely to push commercial prices lower, which will further aggravate the situation once the credit markets unfreeze. The falling value of office towers, which function as underlying collateral, will drive up interest rates and create shortfalls for owners hoping to refinance.
Certainly, the roiling markets are not helping the situation. Dan Fasulo, director of market analysis at Real Capital Analytics in Manhattan, noted that “commercial property needs debt in order to function.”
“In order for there to be a healthy sales market, the capital markets have to right themselves,” Fasulo said. “But there are no loans out there. No one knows what’s going to happen here. There are AAA corporate bonds going to market at ridiculous pricing. We have a major client who said they’re [freezing all new loans] for 30 days.”
“There’s going to be a lot of downward pressure in prices, especially if there’s a situation where we see more forced sellers in the market and if buyers aren’t able to get financing,” he said.
Pro forma gets problematic
But those aren’t the only negative factors. Also darkening the picture for Broadway Partners and others: the reliance during the boom years on so-called “pro forma loans.”
For years, lenders based commercial property mortgages on cash flows from previous years. But during the boom, some buyers engaging in aggressive bidding for trophy towers began borrowing against future cash flows based on anticipated lease and rent increases.
However, as commercial vacancies rise — and many believe they will rise significantly with thousands of Wall Street workers hitting the streets and companies going bankrupt — rents should go down, not up. And when the anticipated higher cash flows fail to materialize,
borrowers like Broadway will have to look elsewhere for money to make their loan payments.
The implications of pro forma lending are already being felt in other segments of the market. Harlem’s sprawling Riverton Apartments is a multi-building residential complex similar to Stuyvesant Town, but some are pointing to its recent troubles as a harbinger of things to come in the commercial sector.
In late August, the owners of the complex, the Rockport Group and Stellar Management, informed their lenders that default on a $225 million loan was imminent. The borrowers had planned to convert rent-stabilized units into fair market units, but were unable to do so as fast as hoped, and found themselves unable to refinance in the current markets.
The default should have come as no surprise: The loan was reportedly underwritten based on projected annual cash flows of $23 million, despite actual cash flows of just $3 million.
One report by Lehman Brothers, which also loaned money to Broadway, blamed “aggressive underwriting” for the Riverton debacle and noted that some commercial properties received similar “pro forma” loans.
No one at Lehman was available to comment on either Riverton or Broadway last month. The bank declared bankruptcy last month and was purchased by the British bank Barclays. But one person with knowledge of the situation confirmed that many of Broadway’s loans were also based on projections that showed lease and rental income increasing in the months ahead.
As a result, Lehman would only make adjustable-rate loans to the firm, instead of more desirable fixed-rate loans.
“They’ve got loans that are rolling, and they didn’t have the cash flow to get fixed-rate loans,” said the source. “They’re coming up for renewal. They’re going to have to do something.”
One area that is already emerging as a potential cash drain is Boston’s John Hancock Tower. In June, Broadway abandoned plans to build a 12,000-square-foot glass “winter garden” on the plaza at the base of the building after community opposition to the project.
The proposal had been inspired, in part, by Harry Macklowe’s Apple Cube in front of the GM Building, and proposed in an effort to add value to Broadway’s investment.
In August, a Boston Globe columnist, citing a “real estate executive with access to the numbers,” noted that Broadway took a long-term mortgage of $640 million to buy the building, along with $472 million in short-term mezzanine financing, for a total of $1.1 billion in debt. But the current value of the building, based on operating profit, is only about $1 billion.
Whether other properties owned by Broadway have similar problems remains unclear. But many industry insiders suspect that this is the case, and Lehman’s situation is likely only to add urgency to Broadway’s predicament.
Fred Stevens, a partner in the financial restructuring and bankruptcy department at Fox Rothschild, noted that the Lehman’s filings so far have been sparse, and the situation is in flux.
If Broadway’s loans are sold to Barclays, the firm would have a new lender to negotiate with and might be able to restructure its loans if it comes to that, Stevens noted. But if the loans stay with Lehman, he said, that could cause problems. “The problem is going to be: Who will be around to negotiate for Lehman?” he said. “Lehman will eventually pay attention to it because it is a valuable asset, but it may be very difficult to find a Lehman employee that is interested and able to negotiate a restructuring, if that is what Broadway Partners is looking for.
“If Broadway Partners is unable to meet the terms of its debt to Lehman, or obtain an advantageous restructuring, it may ironically have to seek the same relief that Lehman is seeking.”
Unloading their holdings
1. In June, Broadway sold the 608,600-square-foot, 31-story high-rise at Houston’s One City Center to Behringer Harvard REIT I for $131 million; the firm had acquired the tower 18 months earlier for $115 million. The building would seem to be somewhat of a success: When Broadway purchased it, the occupancy rate was about 82.2 percent but jumped to nearly 95.5 percent by the time the firm unloaded it.
2. Just after Lehman collapsed on Sept. 23, Broadway announced it had sold Citigroup Center, a 48-story office tower in downtown Los Angeles, to Houston-based Hines for about $280 million.
3. Other sales include a 16-story office tower at 200 State Street in Boston to Germany’s GGL Real Estate Partners for $167 million.
4. Broadway unloaded One Westin Center in Washington, D.C., for $182 million to Washington Real Estate Investment Trust.
5. In May, Broadway sold the 43-story office tower at One Sansome Place in San Francisco, which it acquired in May 2007, for $370 million to the South Korean asset management firm Mirae Asset MAPS. However, that deal has yet to close, and some media reports have speculated it may have problems.