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.

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As prices fell, two investors—Normandy Real Estate Partners, a New Jersey-based landlord, and Connecticut-based Five Mile Capital—began buying up chunks of the Hancock mezzanine loan, at a sharp discount, eventually amassing enough to put them in the driver's seat if Broadway were to default. In January 2009, with the loan balance paid down to $525 million, Broadway Partners defaulted.

On the morning of March 31, a few dozen people showed up at an anti-climactic foreclosure auction staged in a large conference room at the New York law firm Skadden, Arps, Slate, Meagher & Flom. While several parties had expressed an interest in the Hancock Tower, only a single bid was offered—by Normandy and Five Mile. The new owners formally took control of the property, largely by agreeing to assume the existing mortgage. People familiar with the situation believe that somewhere between $350 million and $400 million of the building's debt was written off. By this spring, the building's market value had fallen to about $700 million, losing about half its value in a year.

The saga of the Hancock Tower may seem like a classic case of the difference between genius and idiocy being a matter of luck and timing when you're using lots of debt. Highly leveraged bull-market traders always get caught out when there's a swift correction. But among property magnates, Lawlor was merely the first—and he wasn't doing anything the lions of the industry weren't. Goldman Sachs, long considered the sharpest operator on Wall Street, has taken big losses in its real estate-heavy Whitehall Funds. Macroeconomic changes have upset the thesis of pretty much every purchaser of office space in the last few years. In June, according to CB Richard Ellis, the average asking rent in Midtown Manhattan was off 30 percent from a year earlier—to $60.45 per square foot from $86.57. With job losses continuing, nearly 15 percent of the nation's offices are vacant today, and Jim Costello of Torto Research believes the vacancy rate will rise to nearly 20 percent through 2011—the highest level since 1991, "Even when we start to get some job growth, occupancy levels won't pick up right away."

All of which means more building owners will face the same dilemma that Broadway Partners did earlier this year. In the next few years, nearly $1 trillion in acquisitions concluded between 2005 and 2007, mostly with short-term debt, will have to be refinanced. But owners won't be able to refinance or flip their way out of trouble. The nation's banks, for their part, have about $1.5 trillion of commercial real estate loans on their books. According to the Federal Deposit Insurance Corp., whose troubled bank list has expanded to 416 from 90 in March 2008, the value of real estate loans on which borrowers were more than 90 days or more past due spiked to $67.3 billion in the first quarter of 2009 from about $13 billion in the second quarter of 2007. In the coming months, the recovering banking industry will probably report billions of dollars in losses tied to commercial real estate loans. In the case of the Hancock Tower, the damage has already been done. Investors have written down the value of their holdings, and Scott Lawlor has shored up his operations. In July, he reached an agreement with lenders to cede control of a portion of Broadway Partners' remaining office buildings in exchange for restructuring debt. In Boston, the new owners are seeking tenants to occupy the Hancock Tower's eight empty floors.

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This spring Michael Loughlin, the new manager, was learning his way around the building, He led a visitor past the coffee station near the entrance, through the marble lobby, and up to the vacant 39th floor. Free of desks, cubicles, and partitions, the floor offers stunning 360-degree views of Boston Harbor to the east and the State House and Beacon Hill to the northeast. "There's the Citgo sign," Loughlin noted reverentially, pointing to the billboard that looms over Fenway Park. Without tenants to block the sightlines, the views are priceless. Visitors could be enjoying these vistas for some time.

Newsweek's Stuart Johnson contributed to the reporting for this story, which also appears in this week's issue of Newsweek.

Daniel Gross is a longtime Slate contributor. His most recent book is Better, Stronger, Faster. Follow him on Twitter.

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