How to steal a building in broad daylight
Excerpt from TRD's new book "The New Kings of New York" details one of NYC real estate's most storied transactions
The following is an excerpt from “THE NEW KINGS OF NEW YORK: Renegades, Moguls, Gamblers, and the Remaking of the World’s Most Famous Skyline” by Adam Piore. Order your copy here.
Kent Swig was in the room with the head honchos at Fortress Investment Group, trying to convince them to sign non-circumvent agreements — an unheard-of practice for the distressed-debt investing wizards. But Swig thought he had something that might convince them.
Lehman Brothers, the megabank that had become the de-facto ATM for the real estate industry, had just fallen. Backed by Lehman, Swig had gone on an acquisition and development spree for the ages, buying up huge swaths of Downtown and embarking on big-ticket — and some would say ludicrously ambitious — projects such as the condo conversion of the Sheffield, a stately apartment building at 322 West 57th Street.
But now, the music had stopped. And even residential developers that weren’t heavily leveraged were likely to feel some pain. Buyers looked for any and all loopholes to get out of their contracts. An analysis by The Real Deal found buyers asking for their deposits back on nearly 400 units within 20 buildings.
One novel strategy, pioneered by real estate attorney Adam Leitman Bailey, was to sue on behalf of buyers wanting their deposits back if developers had neglected to meet filing and registration requirements mandated by the Interstate Land Sales Full Disclosure Act. The uncertainty was so great that even those used to preparing for the worst were terrified.
“I wonder how many years that has cut off of all our lives,” Fortress’s Pete Briger, sitting around a polished conference table at the firm’s office, would recall years later.
Fortress was an opportunistic fund built to capitalize on trouble. But this was bedlam. “There were government agencies that were going out of business — Fannie and Freddie,” Briger said. “There were banks that were trading for a dollar or two — household names. Lehman Brothers looked like it hadn’t been marked correctly. It was a full-on change in actual risk and perceived risk. Anybody that wasn’t frightened at that time was just a dope.” Doing the homework, even the kind of exhaustive homework Fortress did before entering any deal, was “not so scientific.”
“You were sort of trying to put things together and understand what your margin for error was, and we had done a lot of due diligence on these situations, but we felt in all the situations that we had a big margin for error,” Briger recalled. “But if the world ended — and there were definitely days when it looked like the world could end — some of the stuff might not be worth what we invested in it. There was no precedent for that.”
Swig’s initial reaction to the Lehman collapse was one of shock and wonder. “No one knows what is going to happen,” he told one reporter. “It’s a bloodbath,” he told another. “It’s extraordinary.” In fact, he was now underwater. And his charm, creativity, and connections wouldn’t be enough of a life raft.
Years later, Swig would sit in a conference room at 770 Lexington, look back on those weeks immediately after the fall of Lehman and shake his head. Up until that day — the infamous “ice bucket incident” with his partner Yair Levy notwithstanding — he could see a path forward. He just needed a little more time.
By July 2008, Swig insisted, he had finished 25 Broad, to “the point where I had little towels on the workout machines with ‘25 Broad’ on them.” He had almost a third of the units under contract with deposits, and the buyers had begun to move in — $138 million worth of sales were on the books. All he needed to do was begin the process of closing them. The money was there. He was ready.
But when Swig had called his bankers at Lehman and asked for permission to close — as stipulated by the terms of his loan — he claims they came back with a curious answer.
“We can’t give you permission,” one told him. “We have to reevaluate everything.”
“What do you mean ‘reevaluate’?” Swig said in response. Swig was still waiting for the situation to be resolved when Lehman declared bankruptcy. And in the subsequent weeks, he insists, he repeatedly attempted to reach his bankers to secure permission to close and convert. No one called him back.
Meanwhile, the money in Lehman accounts used to service his loans was no longer being transferred to 25 Broad. There was no one there to do it. Swig also lost access to the funds he needed to pay his contractors for construction on his Nobu project at 45 Broad. He realized he had no choice but to temporarily shut things down.
By late October, the Nobu project had ground to a halt and the sales office at 25 Broad was closed. Swig filed legal summons against Lehman accusing them of “commercially unreasonable conduct and deliberate delay.” And then, the New York Post got wind of the ice bucket incident.
The absurdity of the attack — wherein Swig and Levy got into a boardroom brawl and an ice bucket was involved — provided much-needed comic relief amid a deluge of apocalyptic headlines. The incident went viral. The real estate blog Curbed seized on the incident, declaring that the fair-haired mogul so used to being lionized in the media would hence forever be referred to as “Buckethead.”
As 2009 dawned, the vise around Swig tightened further. Lawyers for Lehman declared him in default of his loans on the two projects, totaling well in excess of $200 million, and prepared to foreclose. By spring, Swig had shuttered the Nobu project, returned all the deposits at 25 Broad, and walked away. Both projects were functionally dead. The bad publicity, meanwhile, prompted some of his other creditors to take action.
Square Mile’s Jeff Citrin had been watching the debacle that was the condo conversion of the Sheffield closely, and by the end of 2008 had concluded it was time to protect his investors. The chances of Square Mile getting repaid seemed increasingly slim. With the West 57th Street project way over budget and not close to finished, with liens placed on the property, the partners publicly feuding, and the sales market virtually frozen, it seemed likely that the owners of the senior debt on the project would soon foreclose and wipe out Square Mile’s position.
“The project,” Citrin said later, “was a disaster.”
Eager to be first in line for the personal assets Swig had used to guarantee the loan, Square Mile declared him in default on his Sheffield loan. Then seeing no path to a negotiated outcome, they filed in court to collect.
In April, Citibank declared Swig in default of a $5 million personal loan and sued. That same month, some 100 Sheffield condo owners filed a complaint with the New York Attorney General alleging Swig and his partners had failed to pay $5.4 million in common charges over 20 months, and had improperly withdrawn tens of thousands of dollars from the Sheffield’s reserve funds. By then, contractors had placed $6 million in mechanics liens against the units.
After Swig failed to update the condo offering plan with financial disclosures, Andrew Cuomo, then the state attorney general, ordered sales suspended. In May, the Times declared that the Sheffield57 was “already well on its way to being one of the most disastrous condominium conversions in city history.” To add insult to injury, after pleading guilty to harassment and receiving a sentence of two days community service, Levy sued Swig, accusing him of “siphoning off $50 million in construction funds for personal or unrelated purposes” instead of putting it into the Sheffield.
In late spring, Swig learned that Guggenheim Partners, which held a $76 million piece of the debt on the Sheffield, planned to put that debt up for sale. Swig learned that billionaire Stephen Ross’ Related Companies was considering buying the note (a rumor Ross would later confirm had been true).
It was the worst possible scenario, since that particular piece of debt, given its position in the “debt stack,” could be used as a tool to gain control of Swig’s beloved development. The procedure by which this could happen was byzantine. Suffice it to say though that under the laws of real estate finance there were countless ways for sharks to go after the assets held by wounded fish like Swig, and one of the most effective ways was to obtain possession of a strategic piece of the debt on property insiders called “the fulcrum loan,” because it could be used as a lever to gain control.
Swig couldn’t understand why Guggenheim planned to sell its piece, though he would later learn that JPMorgan had foreclosed on the fund and planned to liquidate it. Since Related understood residential, they would have little use for Swig if they acquired the loan. They would have every incentive to use it as leverage to prevent Swig from doing any closings, force the project into default, and take it over.
After weighing his options, Swig made a decision that would sound shocking to many. Swig turned to the same company that had made Harry Macklowe the catastrophic $1.2 billion loan on the Equity Office deal — the deal that nearly ruined him.
Swig decided he needed the guys at Fortress.
He had known Dean Dakolis, who co-headed the real estate group, since the early 1990s. And though he had never done business with Fortress before, he had socialized with a number of the other guys there, including Steve Stuart. Swig knew the Fortress guys to be tough. But he also trusted them, and knew he could speak frankly.
“They had lots of money and lots of brains,” Swig said.
As they convened one morning, Swig told Dakolis and other Fortress executives that what he was about to discuss was very sensitive. That was why Swig was asking them to sign confidentiality and non-circumvent agreements, which would prevent them from discussing the information he was about to reveal or use it to do a deal without him.
“Kent, we never, ever sign non-circumvent agreements,” Dakolis responded.
“I need you to do that, Dean,” Swig replied. “Because I’m going to open up all this, it’s a great opportunity and I want to be part of it because I control it, and I need you to do this.”
Dakolis shook his head. “We can’t do that, Kent.”
“Okay I appreciate it,” Swig said. Then he stood up, packed up his bag, and walked to the door.
“Kent, come back,” Dakolis said. “Okay, why would we sign that? Explain it to me.”
“Two reasons,” Swig said. “One, I’m going to make you very happy, and two, it’s going to be the most successful deal that you will probably ever do.”
“We understand the success part,” Dakolis said. “What’s going to make us happy?”
“I’m going to let you be rough with me and push me over,” Swig replied. “I know you like to play rough. You can knock me out of the way, and you’re going to make a ton of money.”
Dakolis laughed. Finally, he took the paper and signed it. Swig sat back down and explained why he was so bullish on the Sheffield, and then explained how Fortress might step in, foreclose on Swig and his partners, wrest away control of the project and set themselves up for hundreds of millions of dollars in profits.
Swig had paid down the $400 million first mortgage from KeyBank to “nothing” through condo sales — only $32 million remained to be paid, he told them. There was still some work to do on the renovation: The health club still needed to be finished and there were some other common areas that needed to be built out. Yes, some angry tenants remained — they would have to be managed. Even so, the unsold units would eventually be worth far more on the open market than what it would cost to acquire the piece of the mezzanine loan Guggenheim was shopping around.
“Guggenheim, for whatever reason, we don’t know what it is, is putting out their loan and selling it into the open market,” Swig explained. “Something must be going on in their company, because in probably 90 days, they’d be fully paid. I have $65 million of signed contracts already sitting ready to close. Plus I have a bunch of contracts about to be signed.”
Swig said he wasn’t in a position to bid for it on his own, but if Fortress were to step in, buy the Guggenheim debt and allow him to retain a piece of the future profits, he would do everything in his power to help them win control of the property and extract the value. He needed a team used to fighting things out, in court if necessary, a team that could move fast and decisively.
“I want to do it in a venture with you where I’m protected by you inside — I want to be in the Fortress,” he told them. “I don’t want to be on the outside.”
The gambit would rely on a complicated set of procedures laid out in the Uniform Commercial Code. Swig and his partners had bought the building with a total of $400 million — which had been paid down to $32 milion — in a first mortgage, $70 million in equity, and $240 million in mezzanine debt, and had thus sunk roughly $710 million into the property. In the depressed market, of course, the property would never recoup that amount. But Fortress could get it at an extreme bargain.
If Fortress were to buy Guggenheim’s $76 million senior stake in the mezzanine debt, which it could likely get at a discount, and then help Swig pay off the remaining $32 million on the first mortgage, it would become the next in line to get paid. If Swig were then to default on that debt, Fortress would be the senior remaining lender and be in a position to foreclose on the Sheffield.
It would look bad for Swig — he would get massacred in the press. But he was willing to be the fall guy.
Assuming Swig did not put the asset into bankruptcy — which he would pledge to Fortress not to do — the property would then be put up for auction. If Fortress were outbid, any proceeds from the sale of the Sheffield would go to pay off their $76 million senior stake first. Only then would any leftover money go to pay off the next in line in the mezzanine-debt stack — which consisted of seven more tranches totaling roughly $170 million in additional debt.
The math was easy for real estate wonks to do: If they bid and won the auction, they could obtain a property Swig claimed would still eventually yield hundreds of millions of dollars in condo sales for a fraction of the $710 million Swig and his partners had already put into the project. All the debt junior to them would be wiped out.
Any other bidder would have to pay Fortress and all the other mezzanine debt holders in front of them, up to $240 million. Therefore the most likely bidders were JPMorgan, which held a $78 million loan just behind the Guggenheim piece in seniority, and Gramercy Capital, which owned the next tranches in the mezzanine-debt stack, and were thus motivated to at least bid as much as they were owed.
But Fortress had another edge. Only they would know that Swig had promised not to put the asset in bankruptcy. Swig would also voluntarily hand over his condo plan, which would allow Fortress to avoid having to come up with a new one (a process that could take up to 15 months).
Swig would not reveal the deal in the media, allowing the perception that the property had been wrested from him to stand. In exchange, Swig would be granted a portion of any future profits — but only after Fortress had made back its money, and then some.
Dakolis and his partners were intrigued. They promised to look over the numbers. Within just a few days, Swig had a deal.
The Sheffield auction was held on Thursday, August 6, 2009, at the Midtown offices of Fortress’s attorney Kevin O’Shea. In the months following Kent Swig’s decision to approach Fortress, his situation had only worsened. One associate remembers Swig looking like he had been “sleeping on couches.”
By June 2009, Lehman Brothers had filed suit for a $50 million judgment against Swig after he defaulted on $100 million in mezzanine loans at 25 Broad Street, which by then Lehman had foreclosed on and sent into receivership. News reports suggested Swig had personally guaranteed $50 million.
In July, a New York State Supreme Court judge granted a $28.4 million judgment against Swig in the Square Mile case. If Swig and Square Mile couldn’t reach an agreement, all of Swig’s personal accounts would likely be frozen. By then, Square Mile was claiming to have made a shocking discovery in court filings.
Swig, they said, had told them he owned 30 percent of the Sheffield, but they had learned from court filings that his stake amounted to just 9 percent. Swig claimed it was a misunderstanding, but Square Mile seemed to be raising the specter of criminal prosecution. Swig’s marriage, too, appeared wobbly. Still, Fortress’s Chris Linkas said, he put on a brave front.
“A lot of human beings would’ve cracked,” Linkas said. “In his position, at a really important time, he was clear-thinking. He demonstrated a lot of grace under pressure.”
To prepare the auction, O’Shea, who had just done a similar auction in Boston for the John Hancock Tower, cleared two large, low-ceilinged, adjoining conference rooms in the Hilton on 55th Street and Sixth Avenue, filled them with rows of banquet chairs and a podium, and hired a fast-talking professional auctioneer used to selling farm equipment to lead the proceedings. O’Shea also instructed the caterers to scour his offices for empty ice buckets, which he lined in formation at the back of the room in a not-so-subtle homage to the Levy–Swig clubbing.
Interest in the auction was high and it drew some 75 people, including Yair Levy’s son-in-law, possible buyers, reporters, and a number of industry looky-loos (neither Swig nor his partners on the deal were present). In order to qualify for actual participation, interested parties were required to post a refundable $1 million deposit. And as the proceedings kicked off, it seemed clear that Fortress had only one serious competitor for the spoils, JPMorgan. The auctioneer, David Maltz, was so enthusiastic, O’Shea had to tell him to speak slower so people could understand the rules.
As soon as the auction started, Linkas raised his paddle and offered up an initial bid of $20 million, gearing up for what he expected would be a spirited back-and-forth. But when he looked over at JPMorgan’s man, his potential opponent just sat there and “stared straight ahead,” and the paddle remained in his lap. When the auctioneer announced that Fortress’s bid had won the day, Linkas was “stunned.”
For less than $100 million, Fortress had just purchased a building that had sold less than three years earlier for $418 million — a project that Swig was still predicting might eventually yield north of $800 million. Linkas would eventually speak with JPMorgan and learn that the mezz debt was held by two separate funds, and the fund managers could not agree on an auction strategy in time to counter the Fortress bid.
“We stole a building in broad daylight,” Pete Briger would later say.
The above is an excerpt from “THE NEW KINGS OF NEW YORK: Renegades, Moguls, Gamblers, and the Remaking of the World’s Most Famous Skyline” by Adam Piore. Order your copy here.