New York’s real estate professionals are generally an optimistic crowd, but when you ask them about buying loans or properties controlled by special servicers, they turn cool.
In fact, a handful of Manhattan investment sales brokers and company principals say they have given up hunting for opportunities involving special servicers for their clients. Some say their impression is that special servicers rarely sell and, therefore, are not worth approaching.
Others gripe that buying loans from these servicers is so difficult that it’s not worth the trouble.
To rewind a bit, “special servicers” are those companies that stepped in to manage loans that were pooled together and sold off as commercial mortgage-backed securities during the boom, but where the borrowers faltered.
To shed light on the special servicing industry in Manhattan, The Real Deal analyzed data from research firm Real Capital Analytics to provide rarely seen figures revealing how often deals are restructured or sold.
What we found is that behind the scenes there is a lot of activity. And real estate pros say a significant chunk of the existing $5.3 billion in 75 distressed loans in Manhattan currently being serviced will change hands in the coming years. (While that figure includes the $3 billion first mortgage at Stuyvesant Town and Peter Cooper Village, there is still $2.3 billion in play for investors looking to get a piece of the action.)
“If I had to guess, I would say more than half [of specially serviced loans] will require a recapitalization or a transfer,” said Eric Zipkowitz, a partner focusing on distressed real estate at the law firm Tarter Krinsky & Drogin. “Either a vulture or a white knight, someone is going to come in. They’ve got you over a barrel because you are so frustrated from years with a special servicer.”
For example, last month, LNR — the Miami Beach–based special servicer that’s partially owned by landlord Vornado Realty Trust — took control of 246 Fifth Avenue, an office building with a defaulted $14.5 million mortgage. At some point, the special servicer will likely want to sell.
Also last month, LNR transferred the $375 million loan at Extell Development’s 215-unit Upper West Side apartment building the Belnord to another, unidentified special servicer. Nevertheless, annual debt payments are about $9 million more than the building’s net operating income, suggesting that the new servicer will have to modify the loan terms for Extell, or it could end up on the market.
And those two buildings are far from the only examples of troubled loans in New York.
In July, special servicer CWCapital Asset Management filed to foreclose on the $219 million loan on BCN Development’s 315 Park Avenue South. And in April, the $140 million loan on Joe Sitt and Joseph Moinian’s 245 Fifth Avenue was sent to Torchlight Loan Services for special servicing after the owners defaulted because they couldn’t refinance the loan. Insiders expect billions more to hit special servicing, especially because of maturity defaults, in the coming years.
When it comes to working out a distressed situation, sources say special servicers generally want borrowers to make hefty cash infusions — either alone or through a new partner — as a condition for reworking a loan. Yet often, the servicer will move forward with a foreclosure proceeding, which can force the owner out even as the owner is negotiating new loan terms.
Of the $12.5 billion of Manhattan loans that went into special servicing over the past several years, $5.3 billion remains on their books. In only five instances, with a combined value of $290 million, have special servicers foreclosed on and then taken ownership of, the property from the borrowers.
Of those five REOs (properties that are taken back by lenders are referred to as REOs, or “real estate–owned,” meaning that the special servicer kicks out the borrower and becomes the new owner of the property), none have been sold yet.
The largest example is the Riverton Square Apartments in Harlem, which was taken back in a foreclosure auction more than two years ago, and is still controlled by CWCapital. (Stuy Town is not technically an REO because CWCapital has not formally taken title to the property, city records show.)
While brokers may not find comfort in those few sales, owners should. That’s because owners can rest assured that servicers are much more likely to restructure a loan or sell it than finish the protracted foreclosure process.
“What is clear to me is that there are two huge trends among the servicers,” said Ben Thypin, director of market analysis at RCA. “First, they are extremely averse to foreclosure and taking possession of collateral. The second big trend is that servicers are much more likely to liquidate a troubled loan than restructure it.”
Thypin said that if these trends continue, “The most likely outcome for the 75 assets still in trouble are likely to be a short sale, note sale or sale and loan assumption.”
From left: CWCapital CEO Michael Berman; Andrew Farkas, whose company, Island Capital Group, owns special servicer C-III Asset Management; and LNR co-CEO Tobin Cobb.
Dominant players
Three firms — CWCapital, LNR and C-III — lead the distressed loan servicing market in Manhattan today. Of the $5.3 billion that remain in servicing, they control $5 billion, a TRD analysis of commercial servicing data shows.
CWCapital has the most, managing $3.9 billion in distressed loans, including the mega Stuy Town loan. Behind them is LNR, which is handling $658 million in loans, and then C-III with $392 million.
LNR has sold or restructured most of its loans, including the debt on Kushner Companies’ 666 Fifth Avenue. That property is the largest example in the country of LNR’s strategy to cut loans into two parts: a larger A loan and a smaller B loan, used in order to cut near-term debt payments, but not reduce the principal as a way to ultimately increase the likelihood that bondholders will come out whole. After Kushner defaulted on the original $1.2 billion in debt, Vornado and Kushner agreed in December 2011 to inject a combined $110 million in exchange for Vornado getting a 49.5 percent ownership in the office portion of the building.
In the deal — which is no longer distressed — LNR cut the $1.2 billion loan into a $1.1 billion “A” piece, with an interest rate rising from 3 percent to 6.35 percent over five years, and a B note with an original principal value of $115 million.
Over the next five years, that “B” note value will nearly triple to $304 million because of deferred interest payments, a TRD analysis of documents on LNR’s website shows. Vornado and LNR declined to comment for this article.
Yet the restructuring calls for the bondholders and the owners to share in the losses or gains depending on what the building ultimately sells for.
Brokers say LNR is not warm and fuzzy to deal with, though some criticize all firms equally.
“LNR is notorious for being the most difficult to deal with, but also very well known for their structure to rework their loans,” said one active investment sales broker, who requested anonymity when discussing potential clients. (Special servicers will hire a brokerage to market the note on a distressed property — or in the case of a foreclosure, the property itself.)
Still, some said Vornado appears to have gotten a sweetheart deal from the special servicer at 666 Fifth because of its partial ownership of LNR.
Analysts at the Austin, Tex.-based research firm Amherst Securities Group said in a report from January that “investors must still wonder that in the fairly active New York office transaction market, if a higher value could have been realized if the B-note had not been restructured with a shareholder that had an ownership interest in the special servicer.”
But other sources argued that Vornado is taking a substantial risk investing any money behind the massive debt. In addition, 666 Fifth is the only Manhattan property LNR had specially serviced in which Vornado took an ownership through negotiations. The only other property Vornado acquired where LNR had been special servicer was 334 Canal Street, which was purchased at a public auction.
And other real estate firms have purchased special servicers, too.
Andrew Farkas’s Island Capital Group purchased special servicer Centerline Holding, now called C-III Asset Management, in 2010. In August, Bethesda, Md.-based Walker & Dunlop completed the purchase of CWCapital, which is headed by Michael Berman. (LNR is headed by co-CEOs Tobin Cobb and Justin Kennedy.)
By the numbers
Not all of the seven active special servicers in Manhattan operate from the same playbook.
In fact, the difference in how special servicers deal with loans can be stark. Five of the seven most active New York firms — LNR, CWCapital, TriMont Real Estate Advisors, Berkadia Commercial Mortgage and Midland Loan Services — have flushed most of their loans through their systems, either by selling or restructuring them, the TRD analysis shows. (In CWCapital’s case, that excludes Stuy Town, where they are still in control of the loan.)
Meanwhile, two — Torchlight and C-III Asset — have continued to service at least 44 percent of their distressed assets without changing the loan terms.
Perhaps one of the reasons the firms are holding onto many of their distressed loans is because building prices have recovered from the downturn.
“It’s a testament to the resiliency of New York’s real estate market,” said Terrence Oved, partner at the law firm Oved & Oved.
Accepting steep discounts, in hindsight, can look like poor decision-making. Indeed, one of the largest loan sales in Manhattan saw an enormous loss.
On behalf of bondholders, LNR sold the Praedium Group’s defaulted $192 million loan, secured by 32 mostly rent-regulated buildings with 1,039 apartments, to Manhattan property investment firm Dune Real Estate, for just $120 million in November 2011, LNR documents show.
Insiders hoping for more deals like that have argued that special servicers want to hold on to properties to earn the management fees, generally .25 percent of the value of a loan each year. But others argue that the exit fee that a special servicer receives — generally 1 or 2 percent of the loan (or the equivalent of four to eight years in management fee payments) — provides an incentive for the servicer to restructure it.
“The biggest thing with CMBS is that it is an insider’s game,” said one real estate executive, who asked not to be identified because he was not authorized to discuss servicers.
Zipkowitz said it is baffling to deal with the servicers’ bureaucracy and firm-specific standards. He added that the situation is compounded by high turnover at the companies.
Overall, “borrowers have become more and more frustrated with the lack of cohesion and universal standards among competing special servicers,” Zipkowitz added.