Real Estate Record Hits Hurdle
When the private equity firm Somerset Partners announced last month it was acquiring 450 Park Ave. for $1,589 a square foot, a record for a Manhattan office building, it was hailed nationwide as a sign of the historic strength and high demand in the city's commercial real estate market. Now, just weeks later, the firm is struggling to close the $510 million deal, beset by the rising cost of debt.
The purchase of the 321,000-square-foot office building, at the corner of East 57th Street, is only the latest of several high-profile deals that are in turmoil. Metropolitan Real Estate Investors, an Israeli investment group, only just closed on its acquisition of the Lipstick Building at 885 Third Ave. and 292 Madison Ave. after struggling to secure permanent financing, and Harry Macklowe is reportedly in trouble with his $7 billion acquisition of several Manhattan skyscrapers from the Blackstone Group.
At the time these blockbuster deals were struck, they were touted as signs of an escalating real estate boom. Now that they are in trouble, real estate insiders say it portends a potentially severe downturn.
"At the outset, I didn't fully appreciate the depth of the problem," a commercial broker at Eastern Consolidated, Stuart Gross, said. "I had suspected that it would be a handful of guys driving Ferraris in Greenwich who would be unhappy, but as it turned out, it is having a much deeper impact."
Somerset Partners struck its deal with sellers Taconic Investment Partners and the New York State Common Retirement Fund in July, just when initial cracks in the credit market were appearing. The deal, which some say is the highest price ever paid for an American office tower on a square-foot basis, is scheduled to close in early September.
As part of the deal, Somerset Partners is taking ownership of an existing mortgage on the building. Sellers Taconic Investment Partners and the New York State Common Retirement Fund took out a 10-year fixed-rate mortgage for $175 million, which was securitized by Credit Suisse First Boston and cannot be paid off until February. While it works to take ownership of the loan, Somerset Partners is also in the market for additional mezzanine financing. But to get the mezzanine loan, the mortgage lenders must grant the mezzanine lenders certain rights, which they are refusing to do, according to a real estate professional familiar with the deal. At the same time that it is contending with stubborn mortgage lenders, Somerset Partners is also trying to fix mezzanine financing, or preferred equity or debt in a very difficult and pricey market.
"We are in the midst of an assumption of the existing loan," a principal at Somerset Partners, Keith Rubenstein, said. He denied there were issues, and added that it will put in roughly $370 million of its own equity to finance the deal. "In this changing market, there is a flight to quality, and that is exactly what this property is, it is in the most desirable neighborhood in the city," he said.
Somerset Partners is not alone in its situation. "There are tons of lenders reworking deals right now," a principal at real estate advisory firm Ackman Ziff, Patrick Hanlon, said. "A lot of deals are getting re-cut, and a lot of them just won't happen—it will take months, not weeks till this sorts itself out."
Metropolitan Real Estate Investors struggled to find enough debt to finance its acquisition of the Lipstick Building on Third Ave. for $648.5 million and another property at 292 Madison Ave. for $164.5 million. After a struggle to get a loan, it managed to cut a deal with RBC Capital Markets, according to a real estate person familiar with the deal. Mr. Macklowe is said to be at risk of losing his stake in the GM Building if it cannot secure the debt he needs to close his $7 billion purchase of eight Manhattan office towers from the Blackstone Group.
The news is a drastic turnaround from just three weeks ago, when the market seemed to be on a constant upward trajectory. "We have a complete change in the way deals will be made going forward," a broker at Cushman & Wakefield, Yoron Cohen, said. "We will see much more institutional money now rather than hedge funds."
Already, the market is starting to feel the strain, and it isn't just the big deals running into trouble. Mr. Gross thought he had a buyer for a property he was marketing on East 10th Street. But the deal fell through because the buyer failed to get sufficient financing. Now the transaction is in limbo.
To prevent this from happening to his clients, a broker at GVA Williams, Robert Sass, is requiring that buyers interested in a property that he is marketing close within three weeks, so there will be no time to go to lenders to request financing.
"More than ever, cash is king," Mr. Sass said. "I'm intentionally only giving them three weeks to make it very clear to buyers that they should only come to us if they have cash in their pocket."
But this strategy only works with smaller properties. The parcel Mr. Sass is helping to sell, for example, is in the $30 million-range.
For the vast majority of Manhattan office properties, there is a pause right now as interest rates are raised and property prices are revised downward. "When you have pushback in the debt markets, it has to crimp values because your cost of capital is higher," president of GVA Williams, Robert Freedman, said. "This is a structural fact."
