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— Analysis —
It's an early indication of what can happen to those who juiced oversized mortgages with even larger amounts of secondary debt only to find that the property-market collapse makes that short-term loan impossible to refinance when it comes due. It's also evidence of how some private equity players are maneuvering to take advantage of that severe drop in values through foreclosures and distressed sales. "A harbinger of things to come," says one real estate lawyer, who believes we'll see more such auctions and seizure of control through this type of foreclosure, as well as the more traditional foreclosures directly on commercial property.
New England's tallest building cost Broadway Partners $1.3 billion in December 2006. Real estate private equity firm Normandy Real Estate Partners, in partnership with distressed investor Five Mile Capital Partners LLC, bid just $20.1 million at the March 31 auction, which came after Normandy-Five Mile foreclosed on Broadway Partners' mezzanine debt in January. The two will assume the $640.5 million mortgage to the 62-story tower. The total of $660.6 million represents a nearly 50% drop in the nominal value in a little more than two years. That price tag, however, doesn't include the cost the two firms incurred buying mezzanine debt at a discount. Normandy and Five Mile paid perhaps $100 million for the debt. (One source says it averaged "less than 40 cents on the dollar" for a face value of about $340 million.) That represents a total outlay of $760 million. Still, a 40% decline in 27 months is stunning, even for such a massive property with a complicated debt structure. The foreclosure, in fact, wasn't on the property itself but, indirectly, on 100 & 200 Clarendon LLC, the single-asset, special-purpose, bankruptcy-remote, Delaware limited liability company that owns the building. In turn, Scott Lawlor's Broadway Partners had owned Clarendon. Normandy and Five Mile will now gain title to Clarendon. While the 1.7 million-square-foot Hancock Tower and the complexity of its debt are equally outsized, the foreclosure sale may well serve as a preview of an increasingly commonplace occurrence over three to four years, say those in the industry. The amount of maturing debt on commercial real estate won't peak until 2012. While some optimists hope the lending market will have rebounded by then, many others fear that a huge number of buildings like the Hancock Tower, acquired at the height of the bubble with mezzanine debt piled on top of mortgages, are doomed to foreclosure. Lender and borrower alike face twin predicaments. "Mezzanine lenders are going to continue to face dramatic challenges as refinancing of their positions is unavailable and values in commercial real estate continue to drop," says Thomas O'Connor, New York-based chairman of Cooley Godward Kronish LLP's real estate practice. Broadway Partners financed its December 2006 purchase through the mortgage and a $724 million mezzanine debt package, which was used for the tower, a Los Angeles building also sold to Normandy at the same auction in March and three other properties, already sold off. The mezzanine debt was extremely short term, a one-year note, with two six-month extensions. Now-bankrupt Lehman Brothers Holdings Inc. issued the debt along with Greenwich Capital Financial Products Inc. a subsidiary of Royal Bank of Scotland Group plc. Greenwich Capital also held the mortgage. Broadway Partners bought the Hancock Tower near the peak of the market and paid almost $400 million more than what seller Beacon Capital Partners LLC had spent for the building three years before. The 10-year note Greenwich Capital issued carried an interest rate of 5.6%. Greenwich Capital and Lehman securitized the property as part of a $6.1 billion asset-backed securities package in February 2007, Securities and Exchange Commission records show. Most of the remaining money came through the mezzanine financing that Lehman and Greenwich Capital underwrote. By definition, mezzanine loans aren't secured by real estate, but by the company that owns the building or owns the company that owns the company that owns the building. In this case, Lehman sliced the debt nine or 10 different ways, depending on whom you talk to. Interest in this kind of debt is paid out through the building's cash flow of leases and rental revenue. It's a cascading payment structure that pays out higher tranches first but gives the lower tranches a bigger yield. By the time Broadway Partners defaulted, only the first two tranches of mezzanine debt were above water. According to one individual with knowledge of the building's finances, a December 2007 appraisal suggested the fully let skyscraper was worth $1.5 billion. In late 2008, that value had plummeted to $850 million and was dropping fast. Occupancy rates were falling as well. The building is now 85% occupied, with renewals commanding far less money. Boston Class A rentals have dropped some 20% since the peak, according to research by Boston commercial real estate service company Colliers Meredith & Grew. According to a statement, Normandy began buying up the mezzanine debt, at a discount, in June 2008, in a partnership with Five Mile Capital. According to several sources, Normandy established its position by purchasing the second most senior tier of mezzanine debt. At last count, however, Normandy-Five Mile Capital owned a total of between $330 million and $340 million face value of that debt, according to sources. That included the senior-most tranche, the next two tranches, one-half of the third and a piece of the sixth, according to one individual with knowledge of the debt. Just before the auction, the total mezzanine debt tied to the Hancock Tower was $550 million. While it's possible some of mezzanine debt junior to that held to Normandy got some token amount for not holding up the auction, it's safe to assume most of the $210 million was wiped out, as, of course, was Broadway Partners' equity. Technically, the mezzanine debt continues to exist, but the security chain to the building is broken. Broadway Partners defaulted on the mezzanine debt when it came due in January. Under contracts governing this kind of debt, holders of various tranches got together and, with the help of outside appraisers, attempted to figure out how many were in the money. The junior-most of these lenders, known as the fulcrum security, had the right under the agreement to appoint a special servicer. The auction was held under the auspices of the uniform commercial code, or UCC. The result wasn't surprising. Going in, lawyers and bankers assumed that Normandy and Five Mile would control the sale, be the only bidders and bid no more than the outstanding value of its loan. For an outside bidder or junior creditor to prevail, it would have to first pay off Normandy-Five Mile and all creditors senior to it at par. Based in Morristown, N.J., Normandy was co-founded by Finn Wentworth and David Welsh. Wentworth is the former president of YankeeNets, the holding company of the New York Yankees, New Jersey Nets and New Jersey Devils. Welsh was with Morgan Stanley Real Estate Funds. Five Mile Capital, of Stamford, Conn., has $3 billion in assets under management. Gary Holloway, Konrad Kruger, Thomas Kendall and Steven Baum co-founded the firm in 2003. Holloway, Kruger and Kendall were associated with what is now RBS Greenwich Capital. |
Following a mezzanine debt foreclosure auction late last month, Broadway Partners Fund Manager LLC, one of the boom market's most aggressive buyers of commercial real estate, 
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