How Distressed Play Paid Off for Normandy

 
Featured In: Real Estate Alert
The sale of 10 Universal City Plaza in Los Angeles three weeks ago is a classic example of how a high-yield player can clean up by investing in a distressed property.

 

A Normandy Real Estate partnership teamed up with another investor to gain control of the office building in 2009, after Broadway Partners defaulted on debt. At the time, the property was appraised at $275 million. Now, four years later, the Normandy team and a different investor have sold the property to NBC Universal for $400 million.
People familiar with the transaction estimate that the Normandy partnership itself, after a total equity investment of roughly $20 million, walked away with a $50 million profit. That indicates an annual return of more than 30%.
“Ten UCP was a huge home run,” said a West Coast fund executive not connected to the deal.
The investment strategy had some twists and turns. Initially, the 786,000-square-foot building wasn’t even Normandy’s primary target. While the fund operator acquired distressed mezzanine debt that was cross-collateralized by six properties, its main goal was to gain control of Boston’s John Hancock Tower, whose turnaround potential was more apparent.
The Los Angeles building, on the other hand, was facing significant lease rollovers and the expiration of a high-leverage loan. As a result, the Normandy partnership wasn’t sure it would do much better than recoup its equity on that portion of the distressed-debt investment.
But in 2011, Normandy was able to lock in NBC Universal — the main tenant — to a long-term lease, dramatically increasing the tower’s value. It captured a big capital gain when NBC ended up buying the property in the largest California office deal so far this year.
The investment involved gaining the controlling interest in $723.8 million of mezzanine debt that Broadway Partners had lined up from Lehman Brothers and RBS Greenwich. That debt was raised in conjunction with Broadway’s $3.3 billion purchase of an office portfolio from Beacon Capital of Boston in 2006, as the market was peaking.
The mezzanine debt had a one-year term, with two six-month extension options. But as the real estate market tanked, Broadway found itself in a severe debt squeeze.
Normandy, a fund shop in Morristown, N.J., entered the picture in mid-2008, when it teamed up with New York Common Fund on an investment strategy: scooping up mezzanine debt with an eye toward taking control of some of the Broadway portfolio. At the time, Normandy was investing via its $300 million Normandy Real Estate Fund 2. The joint venture between the Normandy fund and New York Common then joined forces with New York fund shop Five Mile Capital on the mezzanine-debt play.
The group first bought a $75 million junior slice of the mezzanine debt at a slight discount from Lehman and RBS. After Broadway defaulted in January 2009, the group continued accumulating mezzanine debt, eventually buying another $150 million of paper at a deep discount. In addition, they bought $40 million of mezzanine debt senior to their other investments at close to par value, in order to solidify their position as the controlling debt holder.
Along the way, Broadway sold four of the six properties tied to the mezzanine debt. That left 10 Universal City Plaza and the trophy John Hancock Tower. The Normandy group was primarily eager to gain control of the Boston property, which, on an allocated basis, accounted for $472.2 million of the $723.8 million mezzanine-debt package. Normandy, New York Common and Five Mile foreclosed in April 2009, assuming that building’s $640.5 million senior mortgage. The group boosted the occupancy rate and then sold John Hancock Tower in December 2010 to Boston Properties for $930 million, reaping a major windfall.
As for 10 Universal City Plaza, Broadway’s allocated purchase price was about $393 million. The fund shop lined up $295 million of senior debt. The allocated amount of mezzanine debt was $23 million, bringing Broadway’s total financing to $318 million.
Although the building was 98% occupied, it was facing significant lease expirations. NBC Universal’s leases on 51% of the space were due to mature in 2008 and 2013. And Universal Music Group’s lease on 15% of the space ran to only 2011.
By March 2009, the building’s value had fallen below the $295 million face amount of the senior debt. Normandy and New York Common bought out Five Mile’s interest and then foreclosed on the 35-story building, effectively converting their mezzanine-debt position to equity. They assumed responsibility for the senior debt.
In projecting the value of their investment in the property, the Normandy fund and New York Common counted only the excess cash that would be generated until the mortgage matured in January 2012 — an estimated $20 million to $30 million, according to people familiar with the matter. With the mortgage underwater and leases on large blocks of space due to roll over, the duo wasn’t counting on being able to refinance and hold on to the property.
Meanwhile, the occupancy rate was falling. In June 2008, NBC vacated 108,000 sf. Then in January 2011, Universal Music vacated its 113,000 sf, pushing the occupancy rate down to 70%. And NBC’s remaining 285,000-sf lease was due to mature in June 2013.
Normandy held early renewal negotiations with NBC in 2011. Late that year, NBC signed a new 12-year lease on 430,000 sf, or 55% of the building. NBC was given rent concessions, but also agreed to move to lower floors, leaving the higher-rent upper floors available for leasing.
The lease renewal paved the way for Normandy and New York Common to refinance the debt and pull out profits. In late 2011, they sold a 49% interest to Morgan Stanley Real Estate’s Prime Property F und in a transaction that valued the property at $360 million. In conjunction with the recapitalization, the Normandy team and Prime Property Fund lined up a $185 million senior mortgage from Citigroup and J.P. Morgan. Also, Prime Property Fund supplied a $100 million mezzanine loan. The proceeds of the two loans were used to help pay off the $295 million of existing debt, with the Normandy team and Prime Property Fund making up the difference out of pocket.
The partners then completed a major lobby renovation and other capital improvements to reposition the building.
Meanwhile, Comcast gained full ownership of NBC in March of this year by buying out its partner, General Electric. NBC then decided to acquire 10 Universal City Plaza, striking the deal to pay $400 million, or $509/sf. The transaction closed Sept. 30.
Because the vacancy rate is still 30%, the capitalization rate was less than 3%, based on the existing rents. It’s unclear whether NBC, whose studio lot is next door, plans to use the vacant space itself or lease it.
The Normandy team and the Morgan Stanley fund used $285 million of the proceeds from NBC to pay off the existing debt, and they split the rest. All told, Normandy and New York Common had put up some $20 million out of pocket during the investment and, after recouping that amount, earned $50 million, the people familiar with the transaction said.