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Some Leveraged CRE Owners Beginning to Find Rescue Capital for Troubled Assets

Banks Appear More Willing to Work with Borrowers on Deals to Recapitalize and Restructure Debt, at Least for Certain Borrowers with Premier Assets
June 23, 2010
Several recent transactions suggest that real estate executives across the country are growing more confident that owners are finally finding common ground with lenders on property valuation, allowing them to dodge foreclosure and recapitalize or restructure their debt -- at least in those transactions involving high-quality assets in prime locations - and buy a fresh start in the gradually strengthening economy.

Tishman Speyer Properties LP pulled off two such agreements with lenders this month -- much-needed wins by a commercial real estate firm that took on quite a bit of debt from acquisitions made during the real estate boom.

Tishman and its equity partners, staring down the barrel of a foreclosure auction by junior debt holder Brookfield Properties Corp., successfully completed a $700 million capital infusion and retired the debt on its portfolio of 28 Washington, D.C.-area office buildings. The prized portfolio includes International Square, a number of prominent Pennsylvania Avenue buildings, Terrell Place, the Commercial National Bank Building and others, plus high-quality assets in Arlington, Tyson’s Corner, Alexandria, Reston and Bethesda.

New York-based Tishman, involved in such iconic properties as New York's Rockefeller Center and Chrysler Center, Berlin's Sony Center and Torre Norte in São Paolo, Brazil, also this month reached an agreement to restructure debt secured by five downtown Chicago office properties it acquired from Blackstone Group LP in 2007. The deal injects fresh capital into the portfolio, "enabling ownership to fulfill all existing financial obligations and fund costs related to future leasing and operation" of the buildings, which include One North Franklin, 161 N Clark, 10 & 30 South Wacker, Civic Opera Building and 30 N LaSalle.

The D.C. deal in particular was music to the ears of market observers watching carefully for signs that office prices are beginning to stabilize, hopeful that the tidal wave of foreclosures predicted by analysts as recently as last year won’t be as devastating as expected.

"I just stepped outside, cocked my ear and heard a huge sigh of relief in the wind all the way from Manhattan and down K Street [in D.C.]," said Benjamin B. Lacy, chairman, Lacy Ltd., a longtime observer of the Washington property market, following news of the company’s successful effort to buy back its debt. "Tishman was very fortunate. I didn’t think they were going to be able to pull it off, but they did."

Tishman declined a request to discuss the capital position it took in the recap, or the level of financial involvement by its equity partners. Those partners include investment company SITQ, the real estate investment subsidiary of Caisse de depot et placement du Quebec of Canada. Tishman said in a prepared statement that "retiring the debt deleverages the portfolio, creates additional liquidity and puts ownership in a strong position to execute its long-term business plan."

The company said it will continue to be the general partner, property manager and leasing agent for all 28 properties, which total 6.3 million square feet and are 88% leased.

"What was at work here was the quality of the properties," Lacy noted. "This is a great portfolio in the best market in the country -- some people say the best in the world. If there was ever going to be a workout that was doable, this was the one. It had all the right things going for it."

However, Tishman Speyer was not as fortunate earlier this year when lenders foreclosed at its massive multifamily development known as the Peter Cooper Village-Stuyvesant Town in lower Manhattan.

Tishman and BlackRock Realty bought the project from MetLife in 2006 for $5.4 billion, hoping to renovate the buildings, bring in upscale tenants and raise rents. However, the state’s highest court last fall ruled that the rent hikes were improper. Loans went delinquent on $3 million in senior debt in January and Bank of America and its special servicer CWCapital Asset Management LLC sued to foreclose. Last week, a federal judge ruled that the foreclosure and auction can move forward.

"Peter Cooper Village-Stuyvesant Town was an untenable situation, a case where the deal just wasn’t strong enough to get a partner in and get a workout done," Lacy said. "But Tishman worked it out in D.C. and Chicago. It proves that certain players in certain markets can do these things. But for others, there are going to be some serious foreclosures."

By most accounts, holders of commercial mortgage debt are just at the very beginning of the lengthy process of unwinding their portfolios of loans to highly leveraged borrowers for property bought at the top of the market in 2005-07. Property owners are expected to face increasingly tough decisions about whether to restructure their debt and retain ownership of their properties or hand back the keys to lenders. Lender syndicates that own the growing mass of maturing CRE loans will eventually need to either exit or restructure that debt, which analysts say will lead to upside return opportunities for patient and well-capitalized investors.

That potential flood of sellers will eventually reach firms like Miami Beach-based LNR Property Corp., the nation’s largest special servicer of delinquent commercial mortgage-backed securities (CMBS) loans. LNR, which also invested in some of the riskiest pieces of CMBS before the market spiraled 2 ½ years ago, announced earlier this month that it is actively pursuing a comprehensive recapitalization through a debt-for-equity swap.

According to reports, Vornado Realty Trust (NYSE: VNO), eyeing a potentially lucrative source of acquisitions, could take a stake in LNR as part of the restructuring. Vornado is also said to have submitted a bid for CW Financial Services, parent of CWCapital Asset Management, the nation’s second-largest CMBS special servicer.

In the complex transaction, existing LNR shareholders and noteholders would cooperate in a $400 million equity rights offering to refinance a loan of nearly $900 million.

LNR, spun off from homebuilder Lennar Corp. in 1997 before being taken private by Cerberus Capital Management (which interestingly, won a bidding war with Vornado for ownership of LNR in 2004), also said Goldman Sachs and Bank of America Merrill Lynch will be lead arrangers for a $445 million new senior secured loan. The combined proceeds of the rights offering and new loan will be used to refinance LNR’s existing $868 million senior secured loan, cancel a $150 million revolver loan and pay transaction fees and expenses. The company's existing $420 million holding company debt would be converted to equity as part of the recapitalization.

Recaps and loan restructurings where investors contribute capital in exchange for a reduced senior loan principal balance and a preferred equity position can provide investors with a lower cost basis and a share of the upside returns, according to bond investment company Pacific Investment Management Co., known as Pimco.

However, "these types of restructurings are complex transactions that will require investors to have substantial capital to participate in larger deals, as well as relationships with both lenders and borrowers," Pimco said. Property pricing may not be recovering to the degree suggested by CRE indexes, and lesser quality assets in the bifurcated distressed property market may be difficult to sell.

Lenders with stronger balance sheets, however, do seem more willing this year to entertain recapitalization deals, noted William R. Lindsay, co-founder of real estate investment firm PCCP, LLC. The San Francisco-based company, has more than $6 billion under management in multiple closed-end funds and joint ventures with institutional investors, headed an ownership group that succeeded in buying back a $212 million construction loan as part of a $300 million recapitalization of The Streets at SouthGlenn, an open-air mixed-use center in Centennial, CO, southeast of Denver.

"Since January 1, we’ve seen a notable increase in the willingness of well-capitalized banks -- banks with earnings -- to consider proposals that are more reflective of what we believe to be the current value of the real estate," Lindsay said. "They have large portions of their balance sheet dedicated to real estate and they know they need to move through it."

Early in the financial crisis, borrowers held more power in working out debt with lenders because banks were busily trying to scour their balance sheets and unwilling to foreclose on commercial property. The pendulum swung in favor of lenders last year as at least the money-center banks gained strength.

In 2010, the pendulum has swung back a bit toward the borrower -- if the borrower is in a position to take advantage of opportunities that are coming as well-capitalized lenders move through their inventory of workout assets -- and "make commercially sensible decisions about what assets to take back, what to modify and what to sell at a discount," Lindsay said.

"We’ve been fairly busy in the first half of this year putting rescue capital into deals because the bid-ask spread between the senior lien holders and the rescue capital has narrowed substantially. Investors are demanding lower returns than they were a year ago," Lindsay said. "Everyone is a little less afraid. The lenders will maybe take less than they thought they’d get, realizing that if they wait longer, it may get worse. The borrower will pay a little more than they wanted to pay. The rescue capital coming in, the new dollars, is recognizing that not everyone needs to get a 30% return."

"Everyone’s now moderating, and that’s why we’re seeing deals happen."

In the case of the Colorado property recap, a joint venture of PCCP, Alberta Development Partners LLC and Walton Street Capital LLC provided the capital infusion for The Streets at SouthGlenn, a mix of retail, entertainment, commercial and residential properties.

The project includes 580,542 square feet of retail, 137,010 square feet of office and 202 apartment units. According to the Wall Street Journal, the JV bought a $212 million construction loan from Bank of America and a separate mezzanine loan as part of the recapitalization. The recap provides the ownership group with "significant working capital" to reinforce the financial structure of the project, which PCCP principal Phil Russick described as "challenging."

"I wouldn’t say all investors are acting with a lot of confidence," Lindsay said. "Valuation is still very problematic and the world is still very volatile. But at the margin, things are a lot different than they were 12 months ago. People can see light at the end of the tunnel now."

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