Watch List (Feb. 25-March 3): Toxic Tenderbox

In this week's issue of Watch List, we report on the unsafe working conditions in the U.S. Department of Interior's massive headquarters; Fitch's latest debt delinquency and default outlooks; the power squabble within self-storage REIT U-Store-It; plus other news and the latest plant closings and properties on the Watch List in Boston; Hauppauge, Henrietta and Flushing, NY; Berkeley Heights, NJ; Raleigh, NC; Columbus and Hamilton, OH; Holland and Westland, MI; Chicago; Cookeville, TN; Mobile, AL; Tulsa; and College Station, Houston, Irving and San Marcos, TX.

Wouldn't Want To Work There

A new internal assessment has found major safety, health and environmental hazards honeycombed throughout the massive U.S. Department of Interior headquarters complex in Washington, DC, according to a "draft final" audit report released today by Public Employees for Environmental Responsibility (PEER).

The Interior complex consists of more than 1 million square feet, including the Main Interior Building, housing an estimated 2,000 workers, at 1849 C St. NW, and the smaller South Interior Building at 1451 Constitution Ave. NW.

The audit team identified a myriad of potentially life-threatening fire safety, electrical and toxic waste violations of federal and District of Columbia regulations.

The Interior's own Bureau of Land Management and a consultant firm conducted the audit from Jan. 22-25, 2007. The final inspection report catalogs a jaw-dropping number of blatant dangers. For example, Interior HQs workers daily risk exposure to a harmful array of chemicals, such as mercury, asbestos and PCBs.

Employee health complaints at the 71-year old Main Interior Building have skyrocketed since it began a 10-year renovation project while it remains occupied. As a result of extensive construction activity aggravated by poor ventilation, employees are routinely subjected to chemical vapors, welding fumes and debris dust.

"Interior Headquarters is a toxic tinderbox just waiting for the right ignition source," stated Jeff Ruch, PEER executive director.

In addition to safety violations, the Interior complex suffers from multiple environmental deficiencies, including inadequate protection of its drinking water from contamination, improper handling of ozone-destroying refrigerants and unlicensed treatment and disposal of toxic chemicals.

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Delinquencies Down

The high amount of December U.S. CMBS issuance helped precipitate yet another decline for CMBS delinquencies as Fitch Ratings' latest loan delinquency index fell another five basis points (to 0.37%.

"Fitch-rated issuance levels increased 11% in December which resulted in another decline in the Fitch CMBS delinquency rate," said Britt Johnson, senior director.

The large amount of December issuance diluted the overall delinquency rates. Excluding deals with less than one year of seasoning, the delinquency rate fell only 1 basis point.

"Delinquency rates in all property types except hotel remained stable," Johnson said.

Hotel delinquencies in January increased by $84 million, most of which was due to one portfolio. The borrower of the loans became 60 days delinquent in January before a discounted payoff was finalized. As of the February distribution date, the loans have been liquidated and losses were incurred by both transactions.

Low Default Rates Unsustainable

While the high yield default rate is expected to remain below average for the fourth consecutive year, Fitch Ratings said it believes that the very low high yield default rate experienced in 2006 is not sustainable and that the risk of a spike in the default rate is substantially higher in 2007 than it has been in the past several years.

The U.S. high yield default rate ended 2006 at 0.8%, down from 3.1% in 2005 and substantially lower than the long-term average annual default rate of roughly 5%.

Profit growth is expected to slow in 2007, debt balances are rising, and investors are likely to become more discriminating going forward, focusing more intently on risk/reward attributes in a maturing credit cycle.

Fitch said that recent trends are already beginning to point in this direction.

Fitch's most recent survey of the financial performance of a sample group of 260 U.S. high yield companies rated 'BB' or 'B' revealed that through the third quarter of 2006, debt had expanded at the highest annual rate in five years (up 12% year-over-year) as new issuance continued to shift away from refinancing as a use of proceeds and toward debt-financed, shareholder-oriented activities, such as leveraged buyouts (LBOs) and mergers and acquisitions. Debt also rose to support capital spending, which for this sample group of companies grew 26% year-over-year.

In addition, the most recent Federal Reserve's Senior Loan Officer Survey showed lending standards among bankers shifting to neutral in the latter part of 2006, a retreat from an earlier bias toward looser lending practices. This suggests that the days of easy money may have peaked.

Beyond macroeconomic concerns, a wildcard weighing on the outlook for 2007 and 2008 is uncertainty surrounding the behavior of the new class of nontraditional U.S. fixed income investors, including hedge funds and foreign investors. At issue is whether these investors, hedge funds in particular, will be tempted to move money out of fixed income strategies in order to pursue higher returns in the rebounding global equity markets.

Family vs. Firm

Robert J. Amsdell, chairman of U-Store-It Trust in Cleveland, retired from the board before the board had a chance to fire him. The company is conducting an inquiry into actions by Amsdell and Todd C. Amsdell, president of U-Store-It Development LLC, a subsidiary of the company, that U-Store-It considers to be in violation of their employee non-solicitation obligations and in violation of their duty to act, in their positions with the company, in the best interests of the company and its shareholders. The company terminated Todd Amsdell.

Robert Amsdell has since expressed disagreement with the company's view and stated that he had left the board to avoid any potential conflict of interest while he pursued, as the company's largest shareholder, strategic alternatives. Amsdell also stated that the Amsdell family was very dissatisfied with the company's performance, and expressed the view that the company should be sold in order to maximize value for its shareholders.

U-Store-It Trust is one of the top five owners and operators of self-storage facilities in the United States.

A Learning Process

Career Education Corp., which leases more than 6.7 million square feet for its schools, is reviewing its real estate needs. It has surveyed all of its real estate and has taken some modest charges in the continuing operations for some other unused space or excess space. It is in the process of marketing some of that space in terms of subleases, said Patrick Pesch, Career Education CFO.

"We are also looking at other individual transactions that may allow us to basically bring our space needs down in certain cases, not our needs down, bring our usage down more aligned with actual student population. This is something that is slow going deal by deal," Pesch said. "We will look as we renew leases to look at smaller amounts of space. We will look at in terms of perhaps moving locations at the expiration of a lease to really get more efficient with the renewals."

Plant Closings

Huttig Building Products, a domestic distributor of millwork, building materials and wood products, closed its distribution facility in Hauppauge, NY, as part of the company's effort to appropriately adjust the size of its infrastructure in light of the recent downturn in the housing market. "While we continue to believe the Long Island, New York market has long term potential for more localized distribution of millwork and specialty building products, unfortunately now is not the time for making the additional investments that would be required in today's market environment," said Jon P. Vrabely, president and CEO of Huttig.

Keystone Powdered Metal Co. is permanently closing its plant at 2100 Advance Ave. in Columbus, OH. There are 52 employees scheduled to be off within a 90-day period, with the first layoff scheduled to occur during the two-week period starting April 20, 2007.

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330 N. Wabash Ave., Chicago

Formerly known as One IBM Plaza, the 1.37 million-square-foot office property has experienced a large decline in occupancy since year-end 2005, largely as a result of IBM vacating the property in August 2006. Current occupancy at the property is 67%. However, Swanson, Martin & Bell LLP, a law firm, renewed its lease this year and expanded its existing space from 1.5 floors to 2.5 floors. It will occupy a total of approximately 68,000 square feet. This lease marks the first major lease renewal at the property since the relocation of IBM. The One IBM Plaza loan has exercised its second maturity extension option to March 9, 2008. It does not have any extensions remaining.

Occidental Center, Tulsa, OK

This 543,572-square-foot office property at 4500 South 129th East Ave. transferred to special servicer in November 2005. A combination of decreased occupancy and decreasing rents caused the borrower's collections to be reduced by 33%. In addition, the borrower had leasing commission obligations that it could not fund. The lender has agreed to a six-month forbearance agreement that calls for $25,000 monthly payments. At the end of the period (March 1, 2007) the borrower will cure all defaults or give the lender a deed-in-lieu.

6464 Savoy Drive, Houston, TX

The loan on this 172,739-square-foot office property at 6464 Savoy Drive transferred to special servicing in June 2006 due to imminent default. The borrower indicated that it was no longer able to continue funding the debt service. A Verizon lease for 101,500 square feet expired on Dec. 31, 2006. The borrower proposed paying off the loan at discount, and those offers were rejected. An offer from an outside party was received to buy the note; the special servicer has gone to market to see if it can get a better offer, than sell the note to the highest bidder.

38 Chauncy St., Boston, MA

The loan is secured by a 130,142-square-foot office property at 38 Chauncy St. It was transferred to the special servicer after the borrower requested debt service relief. The special servicer is working with the borrower to bring the loan current but is pursuing a dual track. Foreclosure was postponed to this week due to a possible assumption of the loan.

Castle Store & Lock, Hamilton, OH

Special servicer, ARCAP. CBRE is actively marketing this 473-unit self-storage property at 1861 Dixie Highway for sale with a $1.8 million list price (reduced from $2.271 million). The property has generated considerable interest, but no offers at a reasonable price. Discussions are underway with a prospective purchaser that is an experienced self-storage operator. A recent appraisal of the property is currently under review. Occupancy continues to hover around 60%. The property generates sufficient cash flow to cover its operations (including taxes and insurance), but not to cover principal and interest.

Westland Colonial Village Apartments, Westland, MI

The loan on this 303-unit complex at 8181 N. Wayne Road was transferred to special servicer in November 2006 for imminent default. After special servicer communications with borrower, rents have been forwarded to a cash management account and the loan was current at least through December 2006. Special servicer and borrower are communicating as to how to cure the non-monetary defaults, which included failure to provide certified annual financial statements and the recording of a mechanics lien. The borrower reported occupancy was 95% as of Dec. 1, 2006.

San Marcos Apartments, San Marcos, TX

The loan was transferred to the special servicer due to payment default. The asset, a 258-unit complex at 1975 Aquarena Springs Drive, became real estate owned in November 2006. The borrower had also failed to provide financial statements as required by the loan documents. A rent roll indicated occupancy at 76% with monthly revenues of approximately $220,000.

College Station Apartments, College Station, TX

The loan on this 240-unit complex at 2001 W. Holleman Drive was transferred to the special servicer due to payment default. A trustee's sale was held in November 2006. The foreclosure bid was $21.6 million. Occupancy currently at 93%. Marketing of the property for sale was subject to approval.

Spanish Haven Apartments, Irving, TX

Special servicer, ARCAP. The borrower on this 168-unit complex at 9874 Dalecrest Drive is requesting a discounted payoff in the amount of $4 million (approximately $700,000 in debt forgiveness). An appraisal of the property has been received and is currently under review, in order to respond to the borrower's request. The loan payment is current, although, should the borrower default on any scheduled monthly payment, the special servicer will engage legal counsel and proceed with demand and acceleration of the mortgage loan, proceeding toward foreclosure.

Whispering Pines of Holland, Holland, MI

Pending contract for sale; 30 days due diligence and 30 day close. Subject is a 144-unit apartment project with 18 buildings, two stories, on 10.37 acres with 136,800 net rentable square feet at 13706 Westwood Lane. As of January 2007, physical occupancy was 79% and economic occupancy was 85%. Average of five nearby rental and occupancy comps reflects 91% occupancy and $525/month rental rates.

Fleetwood Village Apartments, Cookeville, TN

The special servicer, CWCapital, is pursuing foreclosure and anticipates foreclosure on March 8 unless borrower files bankruptcy. Results from an October 2006 property inspection indicated an overall property rating of good. The property consists of nine three-story buildings containing a total of 128 units at 801 Winston Drive. As of October 2006 there were 117 units occupied (91%).

Cherry Lane Owners Corp., Flushing, NY

The value of this 71-unit multifamily cooperative at 42-95 Main St. is approximately $7 million based on a 2006 appraisal. The loan is current and was recently paid down and the outstanding balance is approximately $140,000.

Raleigh Boulevard Plaza, Raleigh, NC

The loan was transferred to special servicer due to the sole member of the borrower, Solomon Dwek, being arrested by both local authorities and the F.B.I. for allegedly attempting to defraud PNC Bank of $47 million. The loan was originated in March of 2005 and is current on monthly payments. The collateral is a 79,232-square-foot retail center at 1100 Raleigh Blvd. anchored by a Food Lion store along with 17 other tenants. An appraisal performed in February of 2005 valued the collateral at $6.4 million.

Walgreens, Berkeley Heights, NJ

The loan was transferred to special servicer due to the sole member of the borrower, Solomon Dwek, being arrested by both local authorities and the F.B.I. for allegedly attempting to defraud PNC Bank of $47 million. The loan was originated in March of 2005 and is current on monthly payments. The collateral is a ground lease for a 15,254-square-foot retail site newly constructed by Walgreens with annual payments of $250,000. The lease is triple net. An appraisal performed in March of 2006 valued the collateral at $3.7 million.

Gateway Computer Store, Henrietta, NY

This 7,995-square-foot retail property at 360 Jay Scutti Blvd. is listed for sale through CBRE for $985,000, through March 7. A recent price reduction from $1.2 million has generated moderate new interest in the property. The Cabot Group manages the property. The property's fully vacant status results in deficit financial operations.

Westmont Inn (formerly Hampton Inn), Mobile, AL

The loan on this 118-unit hotel at 930 S. Beltline Highway transferred to special servicing in December 2006 for a monetary default. Hampton franchise expired in June 2006 and the property is now called Westmont Inn (independent).

Compiled by CoStar Group from the following sources: Fitch Ratings, Standard & Poor's, Moody's Investors Service, CoStar Property Professional, Securities & Exchange Commission CMBS filings; CMBS bondholder reports, Worker Adjustment and Retraining Notifications and corporate news releases.