Affordable Housing Institute : US

In finance, if the borrower makes interest payments, and then the whole sum becomes due and payable at once (a balloon), it’s called a bullet loan. 

If you have a bullet, you better be able to handle the balloon

 

When I describe such a loan to neophytes, I bring my finger up to my temple, to show where a bullet points.

 

Now the thing you have to understand, finance Neo, is how to dodge the bullet.

 

Such a case of spiritual economic arts is being practiced by canny old buccaneer Harry B. Macklowe, as profiled in this intriguing story from the New York Times:

 

IN August 2003, Harry B. Macklowe raced from lender to lender to round up a record-breaking $1.4 billion to buy the General Motors Building, the 50-story commercial skyscraper in Midtown Manhattan that is one of New York’s trophy properties.

 

I like buccaneers. 

 

They dress well, too

 

I’ve worked with them for over thirty years, and there’s something entirely Ross-Thomas about their enterprise, their energy, their zest for the next deal.

 

Just around the next office building

 

Then 66, he gambled mightily to outmaneuver rival bidders and to vault back into the top ranks of New York developers. He went so far as to put down a nonrefundable $50 million deposit and sell many of his residential buildings to raise cash. Some bankers and real estate executives scoffed at the deal, privately suggesting that Mr. Macklowe had overpaid and would drown in an undertow of debt.

 

Not for the first time, Mr. Macklowe, an acknowledged master of winner-take-all real estate poker, proved his skeptics wrong. He expanded and enhanced the valuable retail space of the G.M. Building — on Fifth Avenue at 59th Street — by creating a glass cube for an Apple store that has become a popular tourist destination. As the market soared, Macklowe Properties refinanced the tower twice, most recently in a deal that values it at about $2.7 billion.

 

So it’s evident that Mr. Macklowe is always willing to back his own judgment to the hilt.

 

Neo: If you’re killed in the matrix, you die here?
Morpheus: The body cannot live without the mind

 

If each bet you make is bigger than the one before, there are some anxious moments:

 

But these days Mr. Macklowe is scrambling for financing yet again. He has a $6.4 billion debt payment coming due next month in connection with his purchase of seven other Midtown Manhattan office buildings a year ago. When he bought those buildings from Equity Office Properties [Part of the Blackstone transaction — Ed.], he more than doubled the size of his real estate portfolio and used only $50 million of his own money to do so; he borrowed $7 billion to finance the rest of the purchase.

 

As often happens in real estate, a once-frothy national cycle is losing steam and the market has turned against many buyers.

 

We’re running short on hot air, sir

 

Taking out a bullet loan is in essence a multi-part bet that:

 

1. The financing markets will be tolerant and as good as they were originally, or
2. The property will rise in value, so it can be refinanced, or
3. If the market goes upside down, the borrower can wriggle out of the problems.

Right now Option 1 is kaput, and Option 2 depends — at least in the short term — on Option 1.  So things don’t look good.

 

Agent Jones: We have the name of their next target.
Agent Brown: The name is Neo.
Agent Smith: We’ll need a search running.
Agent Jones: It has already begun.

 

Mr. Macklowe, with his empire of 15 prime office towers and two development sites in one of the world’s best business districts, is awash in expensive, short-term debt at the very moment that financial backing for megadeals has all but shut down. One of his loans is backed by a $1 billion personal guarantee, and he is already in default on $510 million in development loans for a Park Avenue project.

 

You have to admire a man who, having accumulated a substantial fortune, bets ten digits of it on a single loan. 

 

The timing [of his bullet-loan purchases] looked propitious. Credit was so readily available that Mr. Macklowe needed to put down only $50 million. He borrowed the rest in short-term loans from Deutsche Bank and Fortress. But that left him in the dicey position of having to find new sources of permanent financing or equity to pay off the short-term debt.

 

“He went from utter comfort to being on the precipice again,” said one real estate executive who has worked with Mr. Macklowe and asked not to be identified to retain a relationship with the developer.

 

You may question his prudence but you have to admire his convictions.

 

Morpheus: The Matrix is a system, Neo. That system is our enemy. But when you’re inside, you look around, what do you see? Businessmen, teachers, lawyers, carpenters. The very minds of the people we are trying to save.

Mr. Macklowe’s predicament marks the denouement of an unprecedented four-year period in which developers threw gobs of money at real estate as prices for office towers, especially in Manhattan, doubled and tripled almost as fast as sales could be recorded.

 

There’s something supercilious, don’t you think, that now when hindsight is 20-20, it’s so clear to the Times that it can trundle out the loaded words — awash, gobs, avidly, binge.

 

Hey, kids, let’s mock the rich guys

 

Investment banks avidly underwrote the binge, often basing loans not on existing rents but on projections of rental income well into the future.

 

Which, in an environment of structural inflation, is not unreasonable.  Two percent on rents, three percent on expenses, was the residential standard.

 

“In hindsight, everybody should have been more cautious,” said Robert Bach, the chief economist at Grubb & Ellis, the national real estate brokerage firm. “We all knew this wasn’t going to last, but we hoped it would end with a whimper, not a bang.”

 

Bach knew it wasn’t going to last

 

With building owners no longer able to refinance their properties and pull out cash, Mr. Macklowe and his son, William S. Macklowe, have only a month to repay $7 billion, work out a new deal with their bankers or risk the breakup of their empire. There is widespread speculation in the real estate industry that the Macklowes may be forced to unload some of their properties at a discount to creditors — including a sizable stake in the G.M. Building. At worst, they could be forced to shed much of their portfolio.

 

“This is very high-stakes poker,” said Scott A. Singer, the executive vice president of the Singer & Bassuk Organization, a real estate finance and brokerage company in New York. “To owe more than $5 billion in this environment is tremendously risky. There are a very, very limited number of lenders who can make multibillion-dollar loans now.”

 

Here is the crux of Mr. Macklowe’s situation.  Debt usually lacks control; it acquires control rights only when or if there is a default. 

 

Oracle: I’d ask you to sit down, but, you’re not going to anyway. And don’t worry about the vase.
Neo: What vase?
[Neo turns to look for a vase, and as he does, he knocks over a vase of flowers, which shatters on the floor]
Neo: How did you know?
Oracle: What’s really going to bake your noodle later on is, would you still have broken it if I hadn’t said anything?

 

“Our lenders have supported us in the past to an extraordinary degree,” Mr. Macklowe said in an interview in his stark white offices on the 21st floor of the G.M. Building, the evening before he flew south. “We’re pretty confident that, going forward, we’ll be able to achieve accommodations and extensions from our group of lenders.”

 

Part of Mr. Macklowe’s confidence stems from his properties’ underlying value:

 

Though vacancy rates are up nationally, the Manhattan market remains healthy, with the vacancy rate in Midtown, the most desirable business district, just 5.5%.  Because relatively little new space is coming on line in Manhattan in the next few years, the New York market appears to be relatively solid.

 

But fewer deals are being made and rent increases have slowed, if not stopped. If financial institutions continue cutting payrolls, much vacant space could come back on the market and drag down rents, even in Manhattan.

 

So — whose problem is it?

 

 

If you owe a bank a little money, runs the old real estate joke, you have a problem.  If you owe a bank a lot of money, the bank has a problem.

 

Neo: What are you trying to tell me? That I can dodge bullets?
Morpheus: No, Neo. I’m trying to tell you that when you’re ready, you won’t have to.

 

[Continued tomorrow in Part 2.]

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