In an indication of just how far distressed commercial real estate has fallen in value, real estate private equity firm Normandy Real Estate Partners captured Boston's John Hancock Tower through a foreclosure auction Tuesday, March 31. Boston's tallest building cost $660.6 million. That represents a 50% drop in the value of the 62-story property in a little more than two years.
Together with another private equity firm, Five Mile Capital Partners LLC, Normandy bid $20.1 million and will assume the building's original mortgage of $640.5 million. However, that price tag doesn't include the cost the two firms incurred buying mezzanine debt at a discount to help finance the $1.3 billion acquisition in December 2006. Normandy and Five Mile may well have paid upward of $100 million for the debt.
On its own, Normandy bid $10.1 million on a Los Angeles area property, 10 Universal City Plaza. Normandy will assume the mortgage of $294.75 million.
Broadway Partners Fund Manager LLC owned both properties. Scott Lawlor's Broadway Partners emerged as one of the most aggressive acquirers of big commercial real estate during the bubble days of 2006-2007, but is now struggling to stay afloat.
Normandy foreclosed on defaulted mezzanine debt in January. The foreclosure wasn't on the properties itself, but, indirectly. In the case of the Hancock Tower, Normandy foreclosed on 100 & 200 Clarendon LLC, the single-asset, special-purpose, bankruptcy-remote, Delaware limited liability company that owns the building and an adjacent garage. Broadway Partners had owned Clarendon LLC; now, Normandy and Five Mile will gain title to it.
Broadway Partners had financed its purchase through the mortgage and a $724 million mezzanine debt package, which was used for the tower, the Los Angeles building and three other properties, since sold off. The mezzanine debt was extremely short term, a one-year note, with two six-month extensions.
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. The two then sliced the short-term debt into an astounding nine or 10 tranches, depending on who you talk to.
Broadway Partners bought the Hancock Tower near the peak of the market in December 2006 and paid almost $400 million more than what seller Beacon Capital Partners had spent for the building three years previous. The actual mortgage was a 10-year note issued by Greenwich Capital and 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 by the company that owns the company that owns the building or by the company that owns the company that owns the company.
Interest 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, an appraisal in December 2007 suggested the fully-let skyscraper was worth $1.5 billion. In late 2008, that value had dropped to $850 million and was plummeting fast. Occupancy rates were falling as well. The building is now 85% occupied. Boston Class A rentals have dropped around 20%, according to research by Boston-based commercial real estate services company Colliers Meredith & Grew.
According to a prepared statement, Normandy said it began buying up the mezzanine debt, at a discount, in June 2008, in a partnership with Five Mile Capital. According to a number of 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 $340 million face value of that debt. 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 by 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 Partner's equity. Technically, the debt continues to exist, but the security chain to the building is broken.
After Broadway Partners defaulted on the mezzanine 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 most junior of these lenders, known as the fulcrum security, has the right under the agreement to appoint a special servicer.
So, Normandy hired SL Green Realty Corp.'s Green Loan Services as special servicer, which conducted the auction.
The auction was held in the New York offices of law firm Skadden, Arps, Slate, Meagher & Flom LLP, under the auspices of the Uniform Commercial Code, or UCC. While investment bank Eastdil Secured had been hired to market the auction, it was widely assumed that Normandy and Five Mile Capital would control the sale, be the only bidder and bid no more than the outstanding value of what it paid for its loans. That was the assumption because for an outside bidder or a junior creditor to win, it first would have to pay off the Normandy-Five Mile Capital partnership in full.
Based in Morristown, N.J., Normandy was co-founded by David Welsh and Finn Wentworth. Wentworth is the former president of YankeeNets, once 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 is based in Stamford, Conn., and 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 Greenwich NatWest, the NatWest investment bank and its predecessor Greenwich Capital Markets.