Can 11 Times Square hang on?

Like a vertical ghost town, 11 Times Square, the city’s largest speculative office tower, remains entirely unleased more than two years after breaking ground in the summer of 2007.

Some experts give the owners — a partnership between developer SJP Properties and a fund managed by Prudential Real Estate Investors called PRISA — little chance of holding on to the 1 million-square-foot building without a significant debt restructuring, if at all.

They cite the current weak economy, the 25 percent decline in rents, and the cost of the building, a pricey $1,100 per square foot.

Those affiliated with the building, which is located at 640 Eighth Avenue between 41st and 42nd streets, have put on a brave face, however. They say there is a great deal of activity at 11 Times Square, which is being marketed by commercial brokerage CB Richard Ellis.

They also note the building has 51,000 square feet of retail space and 13,000 square feet of signage that can bring in millions of dollars per year. New Jersey-based SJP says the partners can survive through 2012 without any tenants moving in at all.

“Eleven Times Square is approaching completion of construction and has cost savings plus funding commitments that equate to approximately two and a half years of carry post-completion,” an SJP spokesperson said in an e-mail.

Still, the challenges are daunting.

Kevin Comer, senior managing director with finance and development firm Beck Street Capital, said that in most construction projects started over the past three years, the equity has been wiped out and in some cases the debt is overvalued.

“Of all those property types, the most significant hit happened to office rents in Midtown,” said Comer, who has no inside knowledge of the financial structure of 11 Times Square, but follows the development market closely.

“[In] a typical construction project financed with 25 to 35 percent equity, and the balance in debt, the equity is wiped out and the debt is impaired between 10 and 20 percent,” he said.

While it’s unclear how the 11 Times Square owners value the property today, in June the Wall Street Journal reported that Prudential cut the value of its $12.4 billion PRISA fund by 32 percent from a year earlier. The paper also said that investors should brace for another 20 percent write-down.

Prudential said in a statement to The Real Deal last month that despite the downturn in real estate, “we expect to fulfill our commitments to 11 Times Square.”

Yet it also said, “Given the deterioration in the Midtown Manhattan office market, the financial performance of 11 Times Square will not be what we expected.”

The company added, “We continue to believe tenants will demand state-of-the-art office space, so we are confident in the property as a good investment for PRISA over the long-term.”

While few documents are publicly available to analyze private construction projects, according to city records the building carries just $660 million in first mortgages, a relatively healthy debt ratio for a $1.1 billion building.

SJP chief financial officer David Welch told the New York Post in 2007 that his company and the Prudential fund hold a 35 percent interest in the project, which would equate to about $385 million. The partnership purchased the land for $306 million in 2006, city records show.

The balance of the project’s funding appears to come from the $660 million in loans provided by a syndication of seven banks led by PNC Bank and Bank of America.

One of the mortgages, for $252 million, is for hard and soft construction costs.

The loan agreement — which was updated with the New York County Clerk in late June — shows that of the $159 million budgeted for hard costs with the loan, just $3,105 remains. But a building construction loan, unlike a home mortgage, is paid to the developer in monthly installments until it is depleted. Since the project is nearly completed, it makes sense the funds would also be nearly gone.

Other portions of the $660 million loan package include a $224 million loan for non-construction costs; a $73 million loan for predevelopment costs, and several other loans.

On a positive note for the developer, the entire $39 million construction contingency reserve was on hand as of June, according to the loan update.

A spokesperson for SJP disputed equity and loan figures cited by The Real Deal, but did not provide alternative numbers.

Lawrence Longua, clinical associate professor at the Schack Institute of Real Estate at New York University, estimated, based on experience with large construction projects, that the break-even rent for 11 Times Square would be in the range of $75 to $80 per square foot, based on original projected rents of $110 per square foot in 2007.

“But it is only a guess,” he said.

SJP CEO Steven Pozycki, meanwhile, told an audience in May that the hard construction costs for the project are about $300 per square foot.

He said the building would be profitable with rents in the high $70s.

“That is the kind of range that would give us a nice yield on the property,” he said.

Average asking rents in Class A buildings in Midtown are, however, hovering below $70 per square foot, Colliers ABR reported. Worse, taking rents in Midtown have averaged 20 percent below asking rents, a CBRE report last month found.

So it’s not surprising that skeptics wonder where the owners would find money needed to carry future interest payments and pay lease-up expenses. That’s especially true because “tenant improvement” costs, the amount of money a building pays to build out space for tenants, rose 50 percent over the past year to $60 per square foot in August, and free rent saw a similar jump, CBRE reports.

While SJP has stated it can hold on through 2012, the building loan agreement indicates that may not be so simple. The document says the building loan can be extended to 2012 if certain conditions are met by May 2011. Those include a positive cash flow and revenue that covers more than 120 percent of the monthly debt service payments.

However, experts said that 11 Times Square will not have a positive cash flow for years, even if leases start to come in, due to free rent periods, tenant build-out, and other factors.

Longua said the Prudential fund is unlikely to put in any more money. He noted that larger funds, such as the California public retirement fund Calpers, have abandoned development projects in the current downturn.

Some real estate insiders believe a debt restructuring is the most likely outcome for the project, either through delaying interest payments or extending the loan maturity, both popular interim solutions that can give borrowers some breathing room. Others see a more difficult road ahead.

“A building in this state of uncertainty is going to be hard to lease. Tenants are reluctant to go into situations like that,” Longua said.

He and several other industry experts predicted that the building would probably end up back in the lenders’ hands.

“They might as well just formalize [it] and turn over the deed. That way the uncertainty is eliminated.”