Affordable Housing Institute : US

What happens when a property’s capital stack is too high – when the debt substantially overtops its value?  The Law of Economic Gravity  dictates that such capitalization cannot be sustained for long, and as reported in the Boston Globe, in one of the least surprising developments of the global de-leveraging, on April Fool’s Eve, the overlevered John Hancock Building was foreclosed upon by its mezzanine lenders. 

 

Was that a personal guarantee John?

 

NEW YORK — The John Hancock Tower was sold today [March 31, 2009 – Ed.] for $660.6 million at a foreclosure auction in New York City.

 

 

Doesn’t look foreclosed, does it?

 

The signature Back Bay building was acquired by a partnership between Normandy Real Estate Partners and Five Mile Capital Partners, which have been quietly buying some of the debt on the building since June.

 

(Putting ‘Partners’ in your name is a common tag line of private equity investors.)

 

We’re all in this together

 

‘Quietly buying’ is a journalistic phrase for why-didn’t-I-hear-about it?  To which the answer is, “because there was no need for it to be publicized.”  Indeed, there was nothing ‘quiet’ about the private-equity partners’ purchases, as reported in another Boston Globe article:

 

For example, the Hancock is expected to be acquired at today’s auction by two lenders that have quietly orchestrated an effort to buy its debt and seize control of the building.

 

The lenders, Normandy Real Estate Partners and Five Mile Capital Partners, purchased a $75 million slice of debt on the building in June and gradually added more, according to an executive who was briefed on the details of the companies’ transaction.

 

As I predicted in All together now, over the cliff?, their intentions were always evident:

 

Let’s make it simpler: the Hancock’s next lender will be one of its current capital providers.  Most likely these two:

 

Contrariwise, it might be the otherguy

 

Two of those lenders, Normandy Real Estate Partners and Five Mile Capital Partners, have previously asserted that an appraisal of the Hancock determined that they own a controlling portion of the building’s debt, which was divided among multiple parties.

 

Because of that position, Normandy and Five Mile have the best opportunity to buy out other lenders and take control of the building. A spokesman for Normandy declined to comment yesterday. Executives with Five Mile could not be reached.

 

Ask me no questions, I’ll tell you no lies

  

Ten days ago, I predicted these folks will probably double down:

 

When the counterparty is dispersed, the multiplicity of holders means that no one is in charge, leaving the loan servicer compelled to do what the documents say.  And the documents say enforce all your rights, waive none of them.

 

So somebody is likely to start foreclosing on the sponsor, and somebody else is likely to sue to enjoin the foreclosure.

 

According to people familiar with the matter, Five Mile and Normandy believe that they are the controlling holder and are moving to hire a special servicer that would launch a foreclosure proceeding. That move is expected this week.  A joint venture led by the two firms bought the debt in mid-2008 at a discount from Lehman and RBS with seller financing. 

 

In other words, Normandy and Five Mile were sandwiched in the capital stack. 

 

We’ve got crybabies on either side of us

 

They had a first lender in front of them, and other lenders behind them, and they believed their position had some amount of value, but was not fully secured.  So they took steps to broaden their position – and those steps required t hem to put more money in to the capital stack, by buying out their financial abutters.

 

It seems likely that Normandy and Five Mile foresaw this, and believe they can wipe out everybody behind them and capture the upside when the property market comes back.

 

In fact, so foreseeable was this outcome that all the other capital providers in the overextended capital stack saw it too, leading to a simple desultory transaction:

 

The partnership was the only entity to bid for the Hancock during the auction, which lasted less than 10 minutes.

 

Foreclosure = happiness?

 

Yes, Virginia, it’s an auction even if there’s only one bid.

 

Normandy, a leading real estate private firm in the Northeast, will take over management responsibilities of the Hancock.

 

The firm, based in Morristown, N.J., has more than 4 million square feet of space under management in Boston.

 

Thus Normandy (a) had money in the deal, (b) was afraid that the money it had in the deal could be lost, (c) was in a position to operate the property after a foreclosure, and (d) had additional capital available to protect its investment.

 

In making the $660 million bid, Normandy/ Five Mile had also to pay off the first lender.  They probably arranged new financing to do this, but in any case, it’s clear that Normandy/ Five Mile were heading in to the recapitalization waters while the others were heading out.

 

When in danger or in doubt …

 

This is a recognized strategy:

 

The tumult is creating opportunities for some investors, though. Jonathan Davis, chief executive of the Davis Cos. in Boston, said he has purchased $150 million in debt on seven office buildings and expects that defaults will leave him with ownership of some of those properties.

 

“The market is in the early stages of a period of extreme distress,” he said, “owing to the complete abandonment of discretion by certain lenders. Out of that kind of distress always arises opportunity for those with the capital and fortitude to dive in.”

 

Davis likes diving in

 

As I’ve frequently posted, securitization slices up the capital stack.  That slicing can cut both ways.

 

Let’s talk about re-sizing your position

 

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