Surviving a Big Risk on Fifth Avenue
By TERRY PRISTIN
The Kushner Companies’ purchase in 2007 of 666 Fifth Avenue, an aluminum-clad office tower in Midtown Manhattan, for a record price of $1.8 billion is considered a classic example of reckless underwriting. The transaction was so highly leveraged that the cash flow from rents amounted to only 65 percent of the debt service.
As many real estate specialists predicted, the deal ran into trouble. Instead of rising, rents declined as the recession took hold, and new leases were scarce. In 2010, the loan was transferred to a special servicer on the assumption that a default would occur once reserve funds being used to subsidize the shortfall were bled dry.
But the story may yet have a happy ending for Kushner, a family-owned business that moved its headquarters from Florham Park, N.J., to 666 Fifth, its first acquisition in Manhattan. Instead of foreclosing on the 39-story building, which stretches from 52nd Street to 53rd Street, the lenders agreed last month to reduce the principal and defer some of the interest payments on the interest-only loan and extend its maturity for two years, until February 2019. In exchange, Kushner and its powerful new partner in the deal, Vornado Realty Trust, agreed to pour tens of millions of dollars into the building to improve its leasing prospects. The 1.5-million-square feet office building is currently 30 percent vacant.
The modification of the Kushner loan reflects a larger confidence in the city’s long-term future as a financial center. While many commercial mortgages across the country are still in trouble — and more distress is expected — those in New York City are in better shape.
Of the $11.8 billion in commercial loans in Manhattan that were classified as troubled since 2008, just $3.4 billion, or 29 percent, remains in distress, said Ben Carlos Thypin, the director of market analysis for Real Capital Analytics, a New York research firm. About $3.5 billion in loans — covering 14 buildings, including 666 Fifth Avenue, 3 Columbus Circle and 280 Park Avenue — have been restructured.
Borrowers who default are in a much better position today than they would have been in the last downturn, when regulators forced banks to take their losses and swiftly dispose of their troubled loans, said Alexander Goldfarb, a managing director at the brokerage firm Sandler O’Neill. During the last cycle, loans for large office buildings were packaged into securities and sold on Wall Street. Now, the bondholders have a strong incentive to modify their loan terms, often with existing borrowers.
“In the early ’90s, people knew that real estate was going to be purged at so many cents on the dollar,” Mr. Goldfarb said. “This time around, the borrowers know the regulators and the government are on their side, so they can put up a substantial fight.” In states like New York, a foreclosure risks being tied up in the courts for years.
In the recent restructuring of 666 Fifth Avenue, Kushner and Vornado promised not to contest a foreclosure in the event of another default. “The good news about our capital structure is that the loan is in place till 2019, and we have over $100 million that we can spend,” said Jared Kushner, the 31-year-old chief executive of Kushner. “We’ve put ourselves in a position where we can be competitive to attract tenants.”
In the near term, office tenants may not be easy to find. Brokers say large financial institutions are reluctant to make long-term commitments right now because of uncertainty over the European debt crisis and the lingering economic downturn. “We’re in a period of anxiety,” said Mitchell S. Steir, chief executive of Studley, a brokerage firm that represents tenants.
Though 666 Fifth Avenue has some of the most lucrative retail space in the world, the restructuring applies only to the office building. In 2008, Kushner sold a 49 percent stake for $525 million in the building’s retail space — which became a separate condo — to the Carlyle Group, a private equity firm, and Crown Acquisitions. Some of the proceeds were used to pay off Kushner’s $355 million mezzanine loan, thereby enabling the company to hold on to the building.
“It was a very savvy move,” said Howard L. Michaels, the chairman of Carlton Advisory Services and the adviser on the retail sale. In 2010, the Japanese retailer Uniqlo agreed to open a flagship store at 666 Fifth for an eye-popping rent of $20 million a year.
Last year, the partners in the retail space sold one piece of it to the retailer Zara for $324 million, or $8,300 a square foot. Some of those proceeds were used to pay down a separate mortgage they had obtained for the retail condo.
But while the value of the retail space was soaring, the office tower was losing tenants because of its precarious financial situation. Attempts to get the loan restructured began well before the loan was transferred to the special servicer, said Mr. Kushner, who is also the publisher of The New York Observer.
He has been the public face of Kushner Companies, since his father, Charles, was released from federal prison in 2006 after pleading guilty to witness tampering and other charges.
The lengthy restructuring process may have worked to Kushner’s advantage. “The deal they cut now is probably better than the deal they could have cut two years ago,” said Manus Clancy, the senior managing director of Trepp, another New York research company.
Under its terms, the existing $1.215 billion office loan was divided into two pieces — a senior loan of $1.1billion, representing the current value of the building at $835 a square foot, and a subordinate loan for $115 million. These subordinate loans are called “hope” notes since they may never be repaid.
Vornado, which received a 49.5 percent interest in the building, and Kushner agreed to invest $110 million to provide incentives for tenants, pay brokers’ commissions and refurbish obsolete space. Kushner’s $30 million share will come from a modified “air and light” agreement pertaining to a planned hotel for 53rd Street; the hotel’s developers will no longer be blocked from using their own air rights to build extra stories on 53rd Street.
In exchange for putting fresh cash into 666 Fifth Avenue, Vornado and Kushner will have the right to recoup this money (with interest, in Vornado’s case) before the subordinate loan is repaid. “By all appearances, it seems like a fantastic deal for Vornado,” said Robert M. White Jr., the chief executive of Real Capital Analytics.
Vornado has taken an ownership stake in several troubled Manhattan properties. But the 666 Fifth deal raised some eyebrows because Vornado is also a part-owner of the special servicer on the loan, LNR Partners of Miami Beach. Vornado did not respond to a request for an interview.
Kushner was advised by Robert Verrone, who was known as Large Loan Verrone at Wachovia Bank because he financed such large deals as the $5.4 billion purchase of Stuyvesant Town-Peter Cooper Village, the giant housing complex in Manhattan. Mr. Verrone has a new business, Iron Hound Management, and has done $5.5 billion worth of recapitalization and restructuring deals, he said.
Though the 666 Fifth bondholders are worse off now, because the principal is smaller and some interest payments will not be made, they too benefitted from the restructuring, said Frank Innaurato, a managing director at Morningstar. “This mitigates the longer-term loss potential for the deal,” he said. “The lenders are not losing as much as they could have.”