Friday, April 10, 2009

They Say the Neon Lights Are Bright....

John Hancock was famous for his distinctively large signature on the declaration of independence. Psychologists suggest that this is an common mark of someone who is egotistical, cocky, or insecure. As is often the case with insecure people, they often do something to cover up their insecurities by trying to distract the public with something else (if you drive a Ferrari or Lamborghini, I'm looking in your direction). So what was John Hancock so embarrassed about? Well he may not have been clairvoyant, but if he was, he might have been embarrassed by the dearth of activity that the "signature" skyscraper his name bears in Boston, generated at auction recently. Even more embarrassing? The price owner Broadway Partners begrudgingly had to sell the trophy asset for. And you thought the neon lights were bright on Broadway? Turns out the neon lights are dimming, and Broadway may have been better off with the stereotypical Porsche or Viagra.

What Broadway Partners couldn't overcompensate for, however, was the credit crisis, and the disaster overleveraging an acquisition in a declining market would bare. Led by founder and chief executive officer Scott Lawson, the New York based firm was a prolific buyer of real estate assets in the US in the boom years of 2005 to 2007. Having raised just $799 million in two funds, in 2006 Broadway "reviewed 436 transactions with a combined asking price of $75.2 billion," according to fund documents of the Pennsylvania Public Schools Employees' Retirement System.

The John Hancock Tower was part of those deals, after being acquired from Boston-based Beacon Capital Partners as part of a $3.3 billion, 10-building portfolio. The Tower was reportedly sold to Broadway for $1.3 billion.

Like many active buyers during the boom years, debt was key to Broadway's strategy. As the PSERS' document stated, "Broadway continuously monitors the capital markets in order to take advantage of refinancing opportunities and to position the property for the optimal exit strategy."

Of course, strategy and execution are two entirely different things, as Broadway learned the unfortunate hard way. And the end to this fairy tale wasn't a happy one. The auction only generated one measly offer, and the entire process was over in a matter of minutes.

Minimum bids had been set at $20 million dollars (plus the assumption of a $640.1 million dollar mortgage). The winning bid? $20.1 million dollars by a joint venture between Normandy Real Estate Partners and Five Mile Capital Partners. The total capitalization for the deal was just over $700 million dollars, for a building that Broadway paid $1.3 billion for three years earlier. A $600 million dollar loss. That isn't just a haircut, its a scalping!

Yet, this ordeal demonstrates two interesting things. First is that the discounts that savvy real estate investors have been chirping about for months now have started to come to fruition. And if the John Hancock Tower is any indication, there will be some major bargains. The other, more interesting thing of note, however, is just how many players there will be to snatch up these assets.

Perhaps this was a simple matter of a waiting game. Maybe more ready, willing and able buyers are out there, biding their time, sensing that there would be even more pain, and thus better buying opportunities further down the road, than they saw in this opportunity. But only one bidder? For a landmark, trophy asset discounted at nearly 50% of what the seller recently paid for it?

Something tells us this isn't an anomaly. There are too many large real estate operators I know who like to talk opportunity, but in actuality are too busy trying to asset manage thier existing portfolios to truly be focused on vulture acquisition opportunities. Not only that, but even funds that are capitalized well aren't the same as they used to be. The preferred returns they promise investors are ones which they would like to maintain. Without the leverage they were able to get several years ago, especially on bigger sized transactions, buying the same way is almost impossible. Buying with lower leverage cramps down those returns. And lets not forget most opportunity-based funds are investing based on pro-forma returns, not in place current cash flow. Pro-forma today is almost the equivalent of throwing darts at a dartboard. Sure, you can plug in assumptions into your ARGUS model all you like, but assigning probabilities to those assumptions, which make or break the IRR's a model spits out, is anything but easy.

Only time, and more distress will tell the full story. Yet there are many speculators out there who fear that the commercial real estate market, which typically lags economic recession by 18-24 months, will be even worse than the residential debacle. If that is the case, perhaps the John Hancock Tower will seem overpriced in retrospect.

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