Boston's Hancock Tower and the coming commercial real estate crisis.

Commentary about business and finance.
Sept. 5 2009 7:37 AM

The Skyscraper That Ate a Billion Dollars

Boston's Hancock Tower and the coming commercial real estate crisis.

(Continued from Page 1)

Broadway bid aggressively on many properties. But Lawlor almost always lost out to players with deeper pockets. On one building—350 Park Ave., an office tower that the savvy giant Vornado bought for $542 million in 2006—Lawlor's bid was the lowest.

Even though Broadway Partners was making good money, its founder longed to bag a career-defining, home-run deal.

It would come in December 2006. By then, financing was becoming available for ever-larger leveraged buyouts—$20 billion, $30 billion—and rather than buy individual buildings, investors began scooping up huge collections of properties and swiftly selling off pieces of the deal. In the fall of 2006, Sam Zell, the Chicago-based investor whose reputation would take a nick with his disastrous ownership of the Tribune Co., agreed to sell his collection of 543 buildings to the Blackstone Group for $39 billion, including the value of assumed debt. Blackstone began flipping the properties immediately.

Broadway Partners sought to pull off a similar feat—buying a portfolio wholesale and selling it into a hot retail market—by agreeing to pay $3.3 billion for nine properties offered by Beacon Properties, including the Hancock Tower. Lawlor immediately sold three of the buildings for a profit of $180 million and took possession of six properties valued at $2.5 billion. By the time Lawlor became its owner, the Hancock Tower was effectively saddled with two mortgages totaling $1.36 billion.

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Lawlor rejected several unsolicited offers for the remaining buildings, figuring he could either sell at higher prices down the road, or do better by managing the properties and raising rents. The office markets in downtown cities were white hot, and Lawlor believed the Hancock Tower's top floors could command rents of $70 per square foot, up from the $50 or so paid by existing tenants. The price hikes would help generate enough cash to pay off—or refinance—the second mortgage, known as a mezzanine loan, when it came due in January 2009.

Throughout 2007, as subprime lenders failed and housing tanked, commercial real estate held up remarkably well. In the summer of 2007, Broadway was negotiating with a blue-chip Wall Street firm to sell a huge chunk of its holdings in a deal that would have valued the Hancock Tower at $1.7 billion and given Broadway Partners a profit of several hundred million dollars. But in late July, when credit markets seized up in the wake of subprime losses, the buyer disappeared. And then a strange thing happened. Throughout 2007 and most of 2008, as job losses mounted and the world's financial house of cards crumbled, commercial real estate hung in there. "The commercial property market is a lagging indicator," said Jim Costello, principal with Torto Wheaton Research, based in Boston. That's because companies tend to lay off employees only after suffering a few quarters of losses, and it takes them even longer to cut back on their office space.

Over the course of 2008, however, the three interlocking forces that drove real estate prices up—cheap credit, strong fundamentals, and exuberant sentiment—weakened. The tipping point came in September 2008 with the failure of Lehman Bros. Lehman had been both a prolific lender to and purchaser of commercial real estate, with some $43 billion of real estate assets on its books. With Lehman gone and banks in free-fall, the commercial market collapsed. Tenants began to expect lower rents. Lenders and investors began to expect lower prices and to demand tougher credit terms. Instantly, the investment thesis behind so many bubble-era deals changed. And the financial-services companies that had been the mainstay of Boston's—and the nation's—high-end office market began to contract. The advertising agency Hill Holliday, balking at higher rents, had vacated its four floors at the Hancock Tower in March 2008.

Pivoting quickly from an offensive to a defensive posture, Broadway Partners began to market other buildings in its portfolio, aiming to raise money to pay off the $733 million mezzanine loan tied to the Hancock Tower that would come due in January 2009. The Hancock Tower had been appraised at $1.4 billion in June 2008, but now prices were falling. "Since September 2008, sales prices of office buildings fell at least 30 percent," said John Powers of CB Richard Ellis. And there were no buyers. According to research outfit Real Capital Analytics, commercial property sales slumped to $9.8 billion in the first quarter of 2009, from $120 billion in the fourth quarter of 2007.

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