Implications of John Hancock Tower Auction Grim for Commercial Real Estate

Posted by: Aaron Pressman on April 1, 2009

The most iconic building on the Boston skyline, the John Hancock Tower designed by I.M. Pei, sold at auction yesterday for $661 million to bargain hunting investors Normandy Real Estate Partners and Five Mile Capital Partners. The sale followed a default on part of the debt used to finance the purchase of the building for $1.3 billion in 2006. The winning bid, the only bid in fact, was actually $20.1 million plus the assumption of a $640.5 million first mortgage.

How did the winning bidders maneuver into such strong position? By buying up a substantial stake in debt that was less senior than the first mortgage but came due much sooner. In January, the 2006 buyer, Broadway Partners, failed to repay the debt, known as a mezzanine loan, and Normandy and Five Mile moved quickly to put the borrower into default.

But what does the sale say about the value of outstanding commercial real estate loans made during the credit bubble years? According to “Tyler Durden,” the pseudonymous author of the great blog Zero hedge, the true value of the purchase was much lower if you consider the financing involved. Since the new buyers put up only $20 million of a $661 million deal, or about 3%, while keeping the prior mortgage, the deal’s loan-to-value ratio is about 97%. That may have been a reach even during the boom years but is nothing like the ratio that lenders would accept in a typical real estate transaction today. And the rate on that mortgage is a measly 5.6%. The lenders on that first mortgage should get their money back, it seems.

Citing some Wall Street analysis of the deal, Durden figures that in a more typical deal today, the first mortgage would be at a 60% loan-to-value ratio and a rate of 8%, so that would cover only $400 million of the Hancock Tower. Secondary financing on the remaining borrowed amount of $240 million — if it could even get done — would be in the range of 15%. That’s a blended rate of about 11%. The value of borrowing at 5.6% with an 11% yield is $190 million, by the analysis Durden cites, leaving the true cost of the building’s purchase at $470 million, just one-third of what it sold for three years ago. Look out below!

UPDATE: Economist Bill Conerly explains in simple terms why this type of default — where commercial real estate owners are current on their payments but can’t roll over their debt when it comes due — is going to become a tidal wave in coming years:

Suppose you bought an office building five years ago with 20% down, for an 80% loan-to-value ratio. You have not missed a payment, the building’s value has been stable, your amortization has paid down the loan balance by four percent of the building’s original value. A new loan will have a 76% loan-to-value ratio.

Here’s the problem: nobody will make a commercial mortgage loan with a 76% loan-to-value ratio today. You haven’t missed a mortgage payment, your building is fully leased, you’ve been working down your principal, but the lenders are all scared. Bank regulators are scared. Secondary markets are scared. So you have to pony up additional cash to bring the loan-to-value ratio down to at least 70%, and maybe even 65 or 60%.

What if you don’t have the cash sitting around to do that? You have a maturity default. Your problem is that credit standards tightened faster than you were paying off your loan.

(I updated the post on April 2 to make clear for those who didn’t know that Tyler Durden isn’t the Zero Hedge blog author’s real name and clarify that Normandy and Five Mile aren’t, broadly speaking, vulture investors)

Reader Comments

Jeff Rauth

April 2, 2009 8:45 AM

We are seeing a lot of commercial banks re alter their terms on existing ballooning loan (modifying the loan) to avoid having borrowers default. This type of activity should slow down a lot of the "tidal wave" that people are talking about. I would also disagree that rates are in the 8%'s as stated above. Most rates currently are in the mid to low 6% and some in the 5%.

Jeff Rauth
http://www.cfa-commercial.com

Greg

April 2, 2009 10:20 AM

You do realize that Tyler Durden is a fictional name from the book/movie Fight Club?

Henry Duggan

April 2, 2009 9:08 PM

Durden's analysis that the Hancock financing is well below the market -thereby making the adjusted price paid "even less" than the $660M -is probably not realistic.

11% or 15% new loan rates would probably deter any buyers period, so the $661M price should be the true price,as paid. Creativity, as in this deal, could be the norm right now.

Henry Duggan

April 2, 2009 9:08 PM

Durden's analysis that the Hancock financing is well below the market -thereby making the adjusted price paid "even less" than the $660M -is probably not realistic.

11% or 15% new loan rates would probably deter any buyers period, so the $661M price should be the true price,as paid. Creativity, as in this deal, could be the norm right now.

Henry Duggan

April 2, 2009 9:08 PM

Durden's analysis that the Hancock financing is well below the market -thereby making the adjusted price paid "even less" than the $660M -is probably not realistic.

11% or 15% new loan rates would probably deter any buyers period, so the $661M price should be the true price,as paid. Creativity, as in this deal, could be the norm right now.

Dark Space

April 2, 2009 11:46 PM

John Hancock wasn't a maturity default either - it defaulted during the term. The maturity default wave will not be felt in the 10-year balloon fixed-rate universe (which includes this loan) as much because the maturing loans have 10-years of appreciation embedded in them (so new LTVs can be considerably lower and cash can even be taken out as Simon did recently: http://thecrereview.blogspot.com/2009/04/lbcmt-1999-c1-two-simon-loans-refi.html).

The maturity defaults will be more focused on shorter term loans (5-years and less), made over the last 3 years.

Greg

April 3, 2009 1:41 AM

Jeff is a Lender/broker and obviously a young one!
He fails to tell us at what LTV and DSC and at what "value"/term/rate/AM these Balloons are being reduced to.
Mostly he misses the Point of the Article!
Nice try dude.

Greg

April 3, 2009 12:26 PM

Jeff is a Lender/broker and obviously a young one!
He fails to tell us at what LTV and DSC and at what "value"/term/rate/AM these Balloons are being reduced to.
Mostly he misses the Point of the Article!
Nice try dude.

Ollie

April 5, 2009 10:17 PM

Dark Space makes a decent point, but even the maturing 10yr deals are going to run into the general illiquidity in the debt markets, and this would not necessarily cover the resulting cap rate increases in progress right now.
Further, the maturing non-recourse CMBS loans do not now have a new non-recourse option as they are not going to be inclined to offer loan guarantees if they even have the capacity to do so. Do you think these guys are going to dump more cash into deals and hope it all works out or say "market has tanked, I have a non-recourse loan, so here are the keys Mister Lender...".
There is absolutely nothing out there right now that would buoy values until cap rates more appropriately compensate for the risk and headache inherent to this asset class.

Bull Run

April 6, 2009 1:37 PM

Commercial realestate is always the next to fall in a Balance sheet recession, led by financials as this recession is. What is of interest, is the huge amount of Fed funding that has entered the Commercial paper market to prop up liquidity, much of it intertwined with realestate. Many of these comercial paper debts are about be refinanced, the question is can they, at what rate, and how much more "cash in" will be required.The next question is, will the Feds be left with worthless paper. The REAL question that many are asking (G20) as the Feds print more US dollars to bailout America, will the world end up paying for America's "lifestyles" with high exchange rates, or will the world force the Fed into a reality check, with rapid devaluation of the US dollar??

Real Estate Leads

April 7, 2009 1:20 PM

The sale followed a default on part of the debt used to finance the purchase of the building for $1.3 billion in 2006.

Not an Auction

April 8, 2009 6:32 PM

Why does the journalist use the word
"Auction" to describe the sale of this property. Had it been a real auction, True/Fair/Honest market value would have been attained.

Evidently, the journalist should go back to writing stories about Brittney Spears and Miley Cirus, and leave the business writing to more qualified journalist

Jon Churchill

April 13, 2009 10:27 PM

I heard on the news that the Company is urging to open the 60th floor!Please Let me know what the date of the opening is,Jon

Jon Churchill

April 15, 2009 4:41 PM

Hopefully in the next few months from now,The 60th level will open,jon

Jon Churchill

April 15, 2009 4:41 PM

Hopefully in the next few months from now,The 60th level will open,jon

Jon Churchill

April 17, 2009 11:15 PM

I hope the new owner ship is right about the 60 th level,I heard that the new owner ship is urging to open the 60th level

Jon Churchill

May 5, 2009 9:35 PM

I still miss that breath taking View over Boston,Jon

Jon Churchill

August 23, 2009 9:02 PM

This is part of Mr,Tobin`s Job,He`s counting on the new owners to reopen the Viewing point

Steve Alter

September 12, 2009 2:19 PM

I agree that this must not have been an auction because RCM1 provided the online sealed bid auction over the past ten years for the first two times that the John Hancock in Boston was sold. For some reason the ownership of the building and their advisors choose a different path to sell and ended up with far less than they could have had they simpy used RCM1.com again. Real Estate values on commercial property's are down and we all know that so why on earth would the ownership not make sure that their deal was widely exposed to all of the qualified buyers via RCM1 rather than what they did which was hardly expose the deal to anyone. If I were the investors that lost my money on that deal I'd be very unhappy.

Post a comment

 

About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

BW Mall - Sponsored Links

Buy a link now!