After a pair of high-profile foreclosures at the John Hancock building in Boston and Waltham’s Bay Colony Corporate Center last year, industry insiders are scanning the skyline, looking for the next body to fall. A prime suspect is Boston’s 75-101 Federal St.
The building’s owner, Transwestern Investment Co., is struggling to meet the interest payments on a $210 million securitized mortgage. Just three years after paying $260 million in a near-peak market bid, Transwestern is underwater on the property’s $1 million monthly interest payments, according to a pair of CMBS tracking services. The loan has raised red flags at Fitch Ratings, which has labeled the mortgage a loan of concern, indicating a higher probability of default.
If 75-101 Federal falls, it will mark the area’s largest commercial foreclosure since Broadway Partners ceded Bay Colony to Lehman Bros.’ creditors last summer. Avoiding that fate will require Transwestern to shovel millions of dollars into an enterprise that’s currently not worth the debt it’s carrying.
Transwestern, which also owns 40 Broad St. in Boston and Brickstone Square in Andover, did not return calls for comment. Transwestern bought the two-tower Financial District complex from Equity Office Properties in early 2007, when sales of office buildings nationwide were nearing a frothy peak. Bidding was quick and heavy, and Transwestern’s $260 million bid narrowly beat out the Archon Group, despite Archon’s reportedly higher bid. Morgan Stanley financed the acquisition with a $210 million mortgage, which it then packaged into a $1.5 billion securitized bond offering.
Misjudging Rollovers
The office complex – a 1929 Art Deco building connected to a modern 31-story tower – boasted a robust occupancy rate of 91 percent at the time of purchase. That figure has since fallen to 78 percent. The buildings’ single biggest tenant, what was then law firm Edwards & Angell, vacated 80,500 square feet in 2008, taking 14 percent of the complex’s underwritten base rent with it.
Another 19 percent of the complex’s space is set to roll over in 2011. Leasing cost reserves have dwindled to $3.2 million, meaning Transwestern will have to pay significant leasing commissions and space improvement costs out of pocket. Bill Motley, a managing director of downtown brokerage operations for Jones Lang LaSalle, said tenants in the 2011 expiration class are already in the market, looking to take advantage of depressed rental rates.
In 2007, Transwestern and Morgan Stanley actually underwrote significant lease rollover as an asset. The lender and the Houston-based investor bet expiring leases (half the complex’s leases have rolled over, or are set to roll over this year, since Transwestern took ownership) would create an opportunity to drive rental rates skyward.
Rental rates have taken a nasty spill, however. Class A rents in Boston’s Financial District have tumbled 26 percent since July 2008, according to data from Jones Lang LaSalle. Increased vacancies have led to a 15 percent plunge in the buildings’ revenues, Fitch said.
Data from the CMBS deal’s prospectus shows 75-101 Federal’s performance was faltering just before it was acquired. Net operating income (NOI) at the building fell by nearly half between 2003 and 2005, to $10.9 million. Transwestern underwrote NOI at $14.6 million; Morgan Stanley didn’t require the borrower to set aside any reserves against potential cash flow shortfalls.
Monthly shortfalls now appear to be coming out of Transwestern’s coffers, as payments on the mortgage remain current, according to the CMBS tracking firm Trepp. According to Trepp, the property was only generating 64 percent of the cash it needs to keep even with debt payments at the end of 2008, the latest full year for which data is available. Fitch said a blown debt service coverage ratio triggered a cash flow sweep in December 2008. Fitch recently predicted problems at the property could hand the securitized mortgage’s bondholders a 33 percent haircut, based on current cash flows and cap rates.
Stacking The Deck
Some developers and investors have predicted that leasing-driven capital needs, not mortgage maturities, will cause some investors to come to terms with their tenuous positions long before their mortgages come due, forcing distressed properties to market. “I think maturities are not going to be the driver,” Boston Properties President Douglas Linde argued in a July earnings call. “I think it’s going to be frictional transactional activity that’s going to get that stuff unglued sooner, rather than later.”
Should Transwestern decide to sell, or be forced to, it will be entering an already weak market at a time when underperforming assets like 75-101 Federal face even more disadvantages.
“The assets that can trade, and are trading, are the best in the market,” said Scott Jamieson, a managing director in Jones Lang LaSalle’s capital markets group, summing up activity from a year in which sales fell 92 percent from 2007’s high. “Values haven’t gone up, but there’s been a flight to quality. There’s a scarcity value in the market. There is money on the sidelines, and it wants the best core income, or a steal. Anything in between is dormant.”
The fierce competition for core assets has produced some odd sales comps recently. The price Credit Suisse paid for Boston’s Independence Wharf office building, $317 per square foot, is roughly on par with the price per-foot Transwestern paid for 75-101 Federal. But in the time between those two sales, the market has significantly bid up cash-flowing assets like Independence Wharf, while depressing the value of assets with large blocks of vacancy.
New York investors Broadway Partners stacked up piles of debt at Bay Colony in Waltham, so they lost comparatively little of their own cash when they handed the keys back to Lehman. Transwestern sunk $50 million in equity into 75-101 Federal, making the choice between walking away and throwing good money after bad more difficult.
A Better Day
Industry observers told Banker & Tradesman they believe price declines have wiped out Transwestern’s equity, and put some CMBS bondholders underwater. A sale wouldn’t recoup the debt on the buildings. The deal’s master servicer, Wachovia, has not yet transferred the loan to special servicer LNR.
At the moment, both appear content to let Transwestern service its debt out of pocket. The prospect of further vacancy erosion, or the emergence of an opportunistic investor who would buy the complex’s debt and foreclose, could change that calculus.
“Servicers have a lot to deal with,” Jamieson said. “They’re putting out the raging fires and letting the brush fires go. Borrowers are doing whatever they can to pay their debt and hope for a better day.”
