NYC’s Commercial RE Cookie Begins to Crumble

Lehman Bust Hits NYC Commercial Property – Portfolio.com - Felix Salmon – 1 October 08

One of the main drivers of New York City’s commercial property boom was Lehman Brothers. Now that Lehman’s gone bust, the NYC commercial property market seems to have ground to a halt.

It was probably going to happen sooner or later anyway: commercial property prices, just like residential property prices, are governed ultimately by lenders’ risk appetite. But in the world of commercial property, Lehman brothers and a few shops like it were willing to advance 90% of overinflated prices even when rental income didn’t come close to covering the mortgage payments.

They could do so with impunity (or so they thought) because no sooner were such loans advanced than they were bundled up into CMBS and sold off. But invariably the lead bank ended up taking a significant slug of the deal — the primary reason why Lehman went bust.

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Office Leasing Slows in New York to Near Record Low, Study Says – Bloomberg.com – David M. Levitt – 29 September 08

Manhattan office leasing dropped to near a record low in the third quarter, as Wall Street job losses caused corporate managers to put off decisions on their space needs, a study by real estate brokerage Studley Inc. said.

The amount of space available for lease jumped 0.7 percentage point to 8.9 percent, according to the New York-based firm, which specializes in representing tenants. That’s the largest quarterly jump in three years, said the report, which is still in draft form, and is due out early next month…

“Until the last several weeks, most members of the real estate community forecasted a soft landing for the office market,….That now appears to be unlikely. That said, while the impact on the office market will be intense, and likely take eight to 10 quarters to play out, it still shouldn’t be as severe as the collapse induced by oversupply and business contraction in the 1970s and 1980s.”

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Tumult Casts Pall on Manhattan Real Estate – New York Times – Terry Pristin – 30 September 08

As the financial services industry expanded rapidly in mid-decade, Manhattan office rents skyrocketed, investors competed furiously for buildings and developers planned huge trading floors to lure tenants. As recently as last year, large blocks of space were scarce, and landlords had the upper hand.

These days, however, confidence and optimism have given way to fear, uncertainty and gloom. Wall Street is expected to shrink significantly, and the market for commercial real estate has ground to a virtual standstill (though many investors are hopeful of profiting handsomely by choosing the right time to get back in). “The speed at which this has flip-flopped has been stunning,” said Mike Kirby, a principal of Green Street Advisors, a Newport Beach, Calif., research company that analyzes real estate investment trusts. The company follows the Manhattan market closely because one-third of the nation’s public office sector, in terms of its value, is in New York.

Green Street has predicted that the city will lose 60,000 financial jobs before the economic crisis is over and that the Manhattan availability rate could exceed 13 percent (though that is far less than the Manhattan availability rate of 19.8 percent in the third quarter of 1991, the nadir of the last prolonged downturn). The proportion of office space that is empty now, or will be available within a year, rose to 8.9 percent in the third quarter, from 7.2 percent in the second quarter, according to Studley, a brokerage firm that represents tenants.

Most of the increase, however, was attributed to 11 Times Square, a 40-story office tower being built on speculation at Eighth Avenue between 41st and 42nd Street. The building is scheduled to be completed next September, but no tenants have been announced.

At the moment, asking rents in Manhattan are flat, according to Studley, but they are expected to decline as companies seeking to shed excess space sublease it at a discount.

Three of the biggest players caught up in the economic crisis – Lehman Brothers, which is seeking bankruptcy protection; Merrill Lynch, which was acquired by Bank of America; and the insurance giant American International Group, which received an $85 billion bailout from the government – occupy 9.2 million square feet in Manhattan. No one knows how much of this space will be put on the sublease market, or when.

The financial turmoil has prompted some large law firms and other tenants to angle for a better deal in leases.

“They all start by saying that the deal is off,” said a leasing broker who asked not to be named because he was not authorized to discuss his firm’s negotiations. “For some, it really is off. Others are using this as leverage.” Tenants that are not under pressure to make leasing decisions are waiting, he said.

Also waiting are dozens of investors who have amassed billions of dollars of capital but are not ready to spend it because no one knows how much values have dropped. “More money is sitting on the sidelines now than ever before in my lifetime, but nobody wants to risk it,” said Jules Demchick, the chairman of J. D. Carlisle, a New York developer.

The default rate for commercial mortgage-backed securities – bonds backed by loans that are pooled and sliced according to varying levels of risk – is less than half a percent. But real estate professionals say defaults are likely to spike in two or three years when many loans that originated in 2006 and 2007, when the market was at its frothiest, need to be refinanced. The income from these highly leveraged properties is expected to fall short of the robust projections of rental growth that were made when the buildings changed hands.
The collapse of Lehman Brothers will also have repercussions for operators of a number of Midtown office buildings.

In addition to originating loans, selling these loans in commercial mortgage-backed securities and providing “mezzanine” loans at higher interest rates than the senior loans, Lehman was also an aggressive supplier of bridge equity. These were infusions of cash that enabled deals to close quickly, thereby giving its partners a competitive edge. An operating partner might have put up 5 percent of the equity, or even less, with Lehman putting up the balance in the expectation of selling its position to its investors. Often, Lehman played several roles in a given deal.

Lehman frequently provided financing for Broadway Partners, the once aggressive investor in office towers that is now facing a mountain of short-term debt. One of Lehman’s biggest deals in New York involved $1.2 billion in financing for 237 Park Avenue, a 21-story tower that Broadway Partners acquired in May 2007, said Orest Mandzy, the managing editor of Commercial Real Estate Direct, a news and information service. Lehman’s equity positions in Manhattan include the office towers at 1745 Broadway and 545 Madison Avenue, in which it has a minority stake.

In May 2007, Lehman put up most of the $480 million that was used to buy 200 Fifth Avenue, the former International Toy Center, which L & L Holding is turning into a prime office building. Lehman had to keep its interest because the credit squeeze was beginning and no buyers emerged. L & L, which formed a $500 million partnership with Prudential Real Estate Investors in June, hopes eventually to buy Lehman’s stake at a discount. Half of the 15-story building is leased to the Grey Group, a global communications company; the remainder has not been spoken for. A consortium of foreign banks provided a construction loan.

“We are the likely buyer,” said David W. Levinson, chief executive of L & L Holding. He added that the building itself, to be completed in January, will not be affected by Lehman’s demise.
Because he has ready access to cash, Mr. Levinson is in an unusual position, said Robert J. Ivanhoe, chairman of the real estate practice for the law firm of Greenberg Traurig. Some of Lehman Brothers’ other partners are likely to lose control of their buildings. “The typical sponsor is going to have to go out and raise the money,” Mr. Ivanhoe said. “The likelihood of success in this marketplace is remote.”

Anyone who bought a building when the market was red-hot is likely to see an erosion of equity, said Paul M. Fried, a principal of AFC Realty Capital, a mortgage brokerage based in New York. “If you’ve acquired property with highly leveraged capital, you’ve got a problem,” he said. “New York or Washington assets may hold their value better than assets in other markets, but they still may take some hit. And when they take a hit, then your equity has just been devalued.”
But just how deep will that hit be?

The Real Estate Roundtable, which represents the nation’s largest real estate companies, successfully lobbied for commercial real estate debt to be included in the proposed $700 billion government bailout to help establish a fair price for the assets. Jon Southard, a principal at Torto Wheaton Research, an arm of CB Richard Ellis, the brokerage firm, said that under a well-run government auction, sellers would be penalized for overpaying for their buildings because of poor underwriting. But unjustifiably low prices based on panic over the economy would be avoided.

But Mr. Kirby of Green Street Advisors said New York real estate players were perfectly capable of figuring out how much an office building is worth. “Why the government has to play a role there, I don’t know,” he said.

Failed Deals Replace Boom in New York Real Estate – New York Times – Charles V. Bagli – 30 September 08

On Friday, Standard & Poor’s dropped its rating on the bonds used in the record-setting $5.4 billion purchase of Stuyvesant Town, above, and Peter Cooper Village, in 2006.

After seven years of nonstop construction, skyrocketing rents and sales prices, and a seemingly endless appetite for luxury housing that transformed gritty and glamorous neighborhoods alike, the credit crisis and the turmoil on Wall Street are bringing New York’s real estate boom to an end.

Last Friday, HSBC decided not to move its American headquarters to 7 World Trade Center, center, after bids for its existing home on Fifth Avenue came in 30 percent lower than it wanted.
Developers are complaining that lenders are now refusing to finance projects that were all but certain months or even weeks ago. Landlords bewail their inability to refinance skyscrapers with blue-chip tenants. And corporations are afraid to relocate within Manhattan for fear of making the wrong move if rents fall or a flagging economy forces layoffs.

“Lenders are now taking a very hard look at each particular project to assess its viability in the context of a softening of demand,” said Scott A. Singer, executive vice president of Singer & Bassuk, a real estate finance and brokerage firm. “There’s no question that there’ll be a significant slowdown in new construction starts, immediately.”

Examples of aborted deals and troubled developments abound. Last Friday, HSBC, the big Hong Kong-based bank, quietly tore up an agreement to move its American headquarters to 7 World Trade Center after bids for its existing home at 452 Fifth Avenue, between 39th and 40th Streets, came in 30 percent lower than the $600 million it wanted for the property.

A 40-story office tower under construction by SJP Properties at 42nd Street and Eighth Avenue for the past 18 months still does not have a tenant.

And the law firm of Orrick, Herrington & Sutcliffe last week suddenly pulled out of what had been an all-but-certain lease of 300,000 square feet of space at Citigroup Center, deciding instead to extend its lease at 666 Fifth Avenue for five years, in part because they hope rents will fall.

“Everything’s frozen in place,” said Steven Spinola, president of the Real Estate Board of New York, the industry’s lobbying association, shortly after the stock market closed on Monday.
Barry M. Gosin, chief executive of Newmark Knight Frank, a national real estate firm based in New York, said: “Today, the entire financial system needs a lubricant. It’s kind of like driving your car after running out of oil and the engine seizes up. If there’s no liquidity and no financing, everything seizes up.”

It is hard to say exactly what the long-term impact will be, but real estate experts, economists and city and state officials say it is likely there will be far fewer new construction projects in the future, as well as tens of thousands of layoffs on Wall Street, fewer construction jobs and a huge loss of tax revenue for both the state and the city.

Few trends have defined the city more than the development boom, from the omnipresent tower cranes to the explosion of high-priced condominiums in neighborhoods outside Manhattan, from Bedford-Stuyvesant and Fort Greene to Williamsburg and Long Island City. Some developers who are currently erecting condominiums are trying to convert to rentals, while others are looking to sell the projects.

After imposing double-digit rent increases in recent years, landlords say rents are falling somewhat, which could hurt highly leveraged projects, but also slow gentrification in what real estate brokers like to call “emerging neighborhoods” like Harlem, the Lower East Side and Fort Greene.

At the same time, some of Mayor Michael R. Bloomberg’s most ambitious large-scale projects – the West Side railyards, Pennsylvania Station, ground zero, Coney Island and Willets Point – are going to take longer than expected to start and to complete, real estate experts say.

“Most transactions in commercial real estate are on hold,” said Mary Ann Tighe, regional chief executive for CB Richard Ellis, the real estate brokerage firm, “because nobody can be sure what the economy will look like, not only in the near term, but in the long term.”

Although the real estate market in New York is in better shape than in most other major cities, a recent report by Newmark Knight Frank shows that there are “clear signs of weakness,” with the overall vacancy rate at 9 percent, up from 8.2 percent a year ago. Rents are also falling when landlord concessions are taken into account.

The real estate boom has been fueled by a robust economy, a steady demand for housing and an abundance of foreign and domestic investors willing to spend tens of billions of dollars on New York real estate. It helped that lenders were only too happy to finance as much as 90 percent of the cost on the assumption that the mortgages could be resold to investors as securities.

But that ended with the subprime mortgage crisis, which has since spilled over to all the credit markets, which have come to a standstill. As a result, real estate executives estimate that the value of commercial buildings has fallen by at least 20 percent, though the decline is hard to gauge when there is little mortgage money available to buy the buildings and therefore few sales.

Long after the crisis began in 2007, many investors and real estate executives expected a “correction” to the rapid escalation in property values. But after Lehman Brothers, the venerable firm that had provided billions of dollars of loans for New York real estate deals, collapsed two weeks ago, it was clear that something more profound was afoot.

And there was an immediate reaction in the real estate world: Tishman Speyer Properties, which controls Rockefeller Center, the Chrysler Building and scores of other properties, abruptly pulled out of a deal to buy the former Mobil Building, a 1.6 million-square-foot tower on 42nd Street, near Grand Central Terminal, for $400 million, two executives involved in the transaction said.
Commercial properties are not the only ones facing problems. On Friday, Standard & Poor’s dropped its rating on the bonds used in Tishman’s $5.4 billion purchase of the Stuyvesant Town and Peter Cooper Village apartment complexes in 2006, the biggest real estate deal in modern history. Standard & Poor’s said it cut the rating, in part, because of an estimated 10 percent decline in the properties’ value and the rapid depletion of reserve funds.

The rating reduction shows the growing nervousness of lenders and investors about such deals, which have often involved aggressive – critics say unrealistic – projections of future income.
“Any continued impediment to the credit markets is awful for the national economy, but it’s more awful for New York,” said Richard Lefrak, patriarch of a fourth-generation real estate family that owns office buildings and apartment houses in New York and New Jersey.
“This is the company town for money,” he said. “If there’s no liquidity in the system, it exacerbates the problems. It’s going to have a serious effect on the local economy and real estate values.”