Landmark Commercial Real Estate Sold Cheap

This article entitled “Is the Distressed Sale Price of Boston’s Hancock Tower a Harbinger of Things to Come?” appeared on the National Real Estate Investor website on April the 1st, 2009. Sibley Fleming wrote:

“From a seller’s perspective, the sale price of Boston’s iconic John Hancock Tower yesterday was anything but positive. The 60-story building, the tallest in the city, was purchased at a foreclosure auction in New York City by a partnership between Normandy Real Estate Partners and Five Mile Capital Partners for $660.6 million.

That price represents a 50% discount on the $1.3 billion Broadway Partners paid Beacon Capital Partners for the property in December 2006. Beacon paid an estimated $586 million for the asset in March 2003. Normandy Real Estate Partners and Five Mile Capital Partners reportedly had acquired $75 million of the debt on the 1.7 million sq. ft. property in June. Early this year, Broadway defaulted on the loans, putting the lenders in the position to buy the property. The $660.6 million sale price also includes a 2,013-space parking garage and 26,642 sq. ft. of retail space.

“The high levels of indebtedness that commercial properties incurred during the past cycle are adding tremendous pressure in the current downturn, given rising vacancies and falling operating incomes,” says Kyle McLaughlin, a Reis analyst.

Prior to the foreclosure auction, which lasted just 10 minutes and drew a single bidder, Reis estimated the property’s value to be in the range of $650 million to $750 million.

The firm’s valuation was not based on cap rates or comparable sales, given that overall office transaction volume plummeted from $101.5 billion in 2007 to $34.5 billion in 2008 – a whopping 67% decline. Instead, the New York-based research firm arrived at its price based on rent, occupancy and expense projections over a 10-year holding period.

So was the $1.3 billion price tag merited? “In 2007, it certainly seemed like it was justified,” says Victor Calanog, director of research for Reis. In 2006, cheap debt and a robust securitized lending market “allowed a lot of people to raise capital.” In 2007, office rents nationally grew by 10.6%. In New York, over the same period, rents jumped by more than 25%.

Whether or not other trophy properties acquired at the height of the boom will meet a similar fate will largely be dependent upon a given property’s fundamentals as well as the financial health of the property’s owners. “If these are big owners and they have fairly deep pockets elsewhere that can support debt payments for even a property that might not be meeting its actual debt service, then they might be okay,” says Calanog.

During the peak, says Calanog, Reis witnessed transactions closing anywhere from 25% to 30% higher than fundamental values derived from income. “There were deals happening where we couldn’t justify the value on the income the property was generating, even if you were very optimistic about rent growth,” he says.

Reis also conducted an income-based valuation on 666 Fifth Avenue, the former Tishman Buiding. The iconic New York structure was purchased by Kushner Properties for $1.8 billion in January 2007 from Tishman Speyer Properties and German investment firm TMW. The hefty sum was reportedly the highest price ever paid for an individual building in Manhattan.

Valued by rental income in the third quarter of 2008, says Calanog, 666 Fifth Avenue is now worth $1.25 billion, or roughly a third of its 2007 purchase price. The valuation was based on full occupancy and the assumption of a slight rise in vacancy in 2010 and 2011.

But here’s the good news. Unlike past downturns where the office market recovery lagged job growth by 18-24 months, Calanog expects the sector to recover in 12 to 18 months. Why will recovery occur more quickly than in past recessions? The problem today is lack of demand, not overbuilding. “If the economy recovers in 2010, we might see a recovery in early to mid 2011 for rents and occupancies,” says Calanog.

As for a recovery of valuations, he projects, “No time soon.”