Claims that the Back Bay’s iconic John Hancock Tower sold for half price last week are only half right.
A joint venture between Normandy Real Estate Partners and Five Mile Capital Partners scooped up the tower at a foreclosure auction for $660 million last week. The figure is half of the $1.3 billion Broadway Partners paid for the 1.76 million square-foot building in late 2006.
The joint venture’s all-in costs reach beyond that $660 million figure, though. Real estate industry executives believe the true cost of Normandy and Five Mile’s concerted campaign for the Hancock lies in the $800-million range.
That figure would mean the building still traded at a figure well below Broadway’s purchase price, and below the $910 million that Beacon Capital Partners snagged the building for in 2003. But it also pegs the Hancock’s discount between 30 percent and 40 percent – in line with the depreciation many commercial assets have suffered since the recession took hold.
“The final price, $660 million, is not a good reflection of the building’s value,” argued John Gorga, president of Fantini and Gorga. “It’s a reflection that the other prospective bidders knew they had incomplete information. It’s not a true market-clearing auction price. It’s not the value.”
The Back Story
The auction price remained artificially low, Gorga said, because outside investors didn’t jump into the game, knowing that “the deck was stacked against them.”
Normandy and Five Mile bid $20.1 million in the mezzanine auction, and assumed responsibility for the building’s existing debt – a $640.5 million first mortgage that was securitized by Greenwich Capital Partners and Lehman Brothers.
Under auction rules, the partnership was able to count its existing mezzanine debt in its bid. Normandy and Five Mile had been buying up the tower’s mezzanine debt at discounts said to be between 20 and 40 cents on the dollar. That campaign began last June.
Normandy and Five Mile controlled much more mezzanine debt than the $20.1 million they bid with, though. Bloomberg reported the partnership had scooped up all of the tower’s $472 mezzanine debt, at steep discounts. Other industry executives believe some original investors weren’t able to unload their bottom-rung slices of debt, and saw their investments wiped out. (Two candidates in the latter scenario are said to be Greenwich Capital and State Street Bank, which inherited its slice in the Lehman Brothers bankruptcy. Neither firm offered comment.)
Regardless of whether Normandy and Five Mile owned all the Hancock’s mezzanine debt, or just a commanding majority of it, the fact is they had enough of it to control the auction. They owned residual mezzanine debt that wasn’t bid in the auction but could have been deployed, if necessary, to drive the auction price past any competitor’s reach.
To move Normandy and Five Mile, any bidder would have had to bid more than the face value of their mezzanine holdings. The partners had the added leverage of having bought this extra debt at a discount, thereby allowing them to bid cents against dollars.
Keeping Bidders At Bay Costly
This leverage came at a cost, though. The partnership is believed to have spent anywhere from $150 million to $200 million to put themselves in the position to ward off competitive bids. That figure doesn’t show up in the final sale. But it is part of the price paid to control the asset.
Normandy and Five Mile are expected to sink millions more into the building to fill significant vacancies.
“They wind up controlling the asset at substantial discounts,” Gorga said, but because they did so by buying up mezzanine debt behind closed doors, “there’s no way of knowing” how much of a discount the building came at. “You’ll never be able to peg exactly what their basis is.”
Executives familiar with the deal believe that, all told, the partnership’s purchase will come in at a cap rate of six – a ratio calculated using the net operating income produced by an asset in one year and its current market value.
“A six cap today is a pretty aggressive cap,” said Mike Smith, a managing director in Jones Lang LaSalle’s capital markets practice. “Compared to other deals, it’s aggressive.”
