Commercial Real Estate Update

Commercial-Property Players Find Their Pressures Growing
As Crisis Spreads, Market Seizes Up; Capital Preservation
By ALEX FRANGOS
For the commercial-real-estate players that were in hot water before the capital-markets crisis of the past two weeks, the temperature is rising.

Retail giant Centro Properties Group, New York developer Macklowe Properties, office-building investor Broadway Real Estate Partners LLC and others are now facing an even rougher ride in the wake of Lehman Brothers Holdings Inc.'s bankruptcy, the collapse of American International Group Inc. and the buyout of Merrill Lynch & Co. by Bank of America Corp.

After these and other market crises, cash-flow projections for properties are being scaled back in anticipation of a greater economic slowdown. The sales market -- long considered the last hope of many distressed players -- has virtually ground to a halt.

Even creditors that were willing to make real-estate loans before the upheaval are pulling back, having witnessed the spectacle of some of the biggest names in finance and banking vanishing in a period of days.

"In this kind of environment you are not looking to put capital to work," says Lisa Pendergast, managing director of RBS Greenwich Capital. "Most banks and brokerages are in capital-preservation mode."

The demise of Lehman and other events are pushing buyers out of the market or emboldening them to demand lower prices. For example, shopping-center giant Centro Properties Group, which faces a Sept. 30 deadline to pay off $2.3 billion in debt, had a pending deal to sell 29 U.S. properties to DRA Advisors for $714 million. The deal collapsed last week after Centro refused DRA's request for a price cut.


Getty ImagesTo be sure, commercial real estate so far has fared better than residential properties. Many office buildings, shopping centers, warehouses and other income-producing properties are generating enough cash to pay their debt, and their default rates remain low.

Nevertheless, values have fallen because of the credit crisis and economic uncertainty, which is in particular creating headaches for investors who bought at the top of the market with short-term debt. Financial institutions holding mortgages backed by commercial real estate have suffered tens of billions of dollars in losses and face more.

In the long run, liquidity might be restored to the market by the government's proposed $700 billion financial-bailout plan, which partly involves buying troubled commercial-real-estate debt. But many institutions may be reluctant to accept the government's price if steep discounts are required because the underlying real estate may still be performing well.

The help also will take time to reach owners who are under stress from high debt loads. "This will absolutely help commercial real estate," says David Lichtenstein of the Lightstone Group, which accumulated billions of dollars in real estate near the top of the market. But, he says, "I don't think fixing a few Wall Street banks will fix a grass-roots issue we have here. We are going through a huge devaluation."

At the same time, the benefit from the government bailout will be partly offset by the conversions of investment banks Goldman Sachs Group Inc. and Morgan Stanley into more risk- and leverage-averse commercial banks.

"We are very capital-intensive and require a lot of debt to keep our businesses running," says Jeff Blau, president of Related Cos., a New York developer.

In the near term, commercial-real-estate markets have been particularly devastated by the bankruptcy of Lehman Brothers. The firm owned more than $32 billion of debt and equity assets -- running from land in California to apartment buildings in Boston -- that will now be liquidated, putting downward pressure on prices.

Complicating things further, Lehman pledged many of its real-estate assets as collateral on loans for desperately needed cash in the days before it collapsed. For example, Swedbank AB, a Swedish bank, was left holding 70 commercial loans valued at $1.35 billion, which were backed by properties including partially built developments. It is unclear if Swedbank will fund the balances to keep construction going.

The financial crisis of the past few weeks also has hurt the economic outlook for many properties, particularly office buildings in New York and other financial centers.

In a worst-case scenario, in the New York region, vacancy will hit 19% by 2011 and values will scale back over 13% through 2009, according to a projection scheduled to be released Wednesday by Property & Portfolio Research Inc.


Harry Macklowe
Epitomizing the current troubles: Macklowe Properties' Harry Macklowe appeared to have appeased most of his creditors and salvaged some of his empire earlier this year when he sold his prize General Motors building and other office towers. But now he is facing new troubles. His office development at 510 Madison Ave. has leased only one floor amid Manhattan's bleak leasing market. Meantime, creditors have launched a foreclosure against another one of Mr. Macklowe's projects, a mixed-use development at the site of the old Drake Hotel. Mr. Macklowe has been struggling for months to find a partner, but his prospects are even worse now.

In another closely watched situation, U.S. mall owner General Growth Properties Inc. faces the task of refinancing and paring its $27 billion debt load, of which nearly $19 billion is due by the end of 2011. The Chicago-based company said earlier this week that it has broadened its efforts to raise capital to include a big capital infusion, a merger and more property sales than it initially targeted.

Still, the company's task is "materially more difficult than it appeared previously," Green Street Investors analyst Jim Sullivan said.

Broadway Partners, a closely held real-estate fund manager, has made progress in recent months toward stabilizing its portfolio. Broadway faces a $750 million loan expiration in January that it used to acquire $7 billion of office skyscrapers at the top of the market in 2007, including Boston's signature John Hancock Tower. Broadway has sold two towers to raise money, but several more remain in contract and could run into trouble now that market turbulence has increased. The sale of One Sansome Street, a tower in San Francisco, was expected to sell over the summer to a Korean investment fund, but the deal has yet to close.

"It's the absolutely wrong time to be a seller," says Gary Mozer of George Smith Partners, a brokerage in Los Angeles.

Richard Coppola, managing director of commercial-mortgage investments for TIAA-CREF, the largest U.S. retirement system, predicts lending costs will rise. "We want to make sure that we're compensated for the risk we take on over the long term," he says.
Chris' comments: It now appears that the contagion in the residential real estate market has spread. Commercial Real Estate is now under stress and who knows how deeply the problems will run? stay tuned.