Wednesday, July 20, 2011

GIC's Failed New York Real Estate Investment: An In-Depth Analysis

Stuyvesant Town. 

While recently in Singapore, I encountered lively debate about Singapore’s two sovereign wealth funds, the Government of Singapore Investment Corporation (known as “GIC”) and Temasek Holdings. Given Singapore’s reputation for clean government, some citizens grumbled about the lack of transparency with which these funds operate. I first became curious about GIC last year after learning of their $675 million + loss in the default of a New York apartment community known as Stuyvesant Town/Peter Cooper Village at the beginning of 2010.

The failure of Stuyvesant Town/Peter Cooper Village at the beginning of 2010 resulted in the largest real estate foreclosure [actually “deed in lieu of foreclosure”] in U.S. history. These two aging apartment communities, with a total of 11,250 apartments, were together purchased for $5.4 billion in 2006 in a syndication organized by Tishman Speyer and BlackRock; there was also $4.4 billion in first and mezzanine financing. The purchase price equated to $480,000 per apartment in two complexes that were built in the 1940s, equating to an annual gross rent multiplier of more than 30, unheard of for an American apartment property not headed for condo conversion (but perhaps common in Singapore).

73% of the apartments had rents restricted by New York’s Rent Stabilization Ordinance, and the average rent for a one-bedroom apartment was about $1300 per month at the time. At the time of purchase, market rents on one-bedroom apartments, once renovated, were estimated to be $3200 to $3500 per unit.

The loans were underwritten not according to present income but according to pro forma income expected in 2011, five years hence. Net operating income was forecasted to triple in five years! Tishman reportedly planned to more actively manage the property than previous owner MetLife, and thought rents could be raised through renovation and the eviction of or renegotiation with illegal tenants, estimated to occupy about 1000 units. MetLife previously also had a plan to convert the units into luxury apartments, but found itself legally confounded by tenant litigation. They basically tried the same strategy before and failed.

Enterprising New Yorkers sometimes pretend to keep possession of apartments with restricted rents while subletting to other unrelated parties. Tishman planned to aggressively raise rents on these illegal subletters. One problem, though, was that under the Rent Stabilization Ordinance, stabilized rents below $2000 per month are not eligible to be raised to market value, and most of the units were earning less than $2000 per month.

My personal observation is that New York is a very litigious city (I had an appraisal office there in the 1990s). I have been threatened with lawsuits just for calling up buyers or sellers and asking them what they paid for their properties. MetLife had already been stymied by tenant lawsuits, so Tishman should not have been surprised that its aggressive rental increase program would also attract a class action lawsuit on more than 4000 units. The courts judged $200 million in rental increases to be illegal and awarded $4000 to each renter.

Besides ruinous legal expenses, the financial industry meltdown had hit the New York apartment rental market hard, and market rents were falling. Asking rents on one bedroom apartments at Stuyvesant/Cooper had declined to $2255 per month at the time of foreclosure, not including a $500 move-in bonus.

The first mortgage loan was underwritten at a 1.7 debt coverage ratio based on pro forma Year 2011 NOI, but actual first year debt coverage in year 2006 was only .48! Having worked for America's largest multifamily lender in the 1990s, a deal like this would never have been done. Including the mezzanine debt, the 2011 DCR would have been only 1.2. Even more surprising was that there were two pieces of mezzanine debt, and GIC held the subordinate piece, $575 billion, which became worthless at the time of foreclosure. The superior mezzanine lien at least received $45 million.

What this meant for equity investors was years of red ink before the property could earn positive cash flow. When the projections became unattainable, there was no more reason for the investors to hold on to the properties, and the lenders took possession.

The most recent appraisal of this complex estimated market value at about $2.8 billion, meaning a potential loss of about $2.6 billion for the consortium of lenders which include Wachovia (now Wells Fargo), Merrill Lynch (now Bank of America), GIC and the other mezzanine lender.

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