Oct. 2 (Bloomberg) -- Tishman Speyer Properties LP and BlackRock Realty's $5.4 billion investment in Manhattan's biggest apartment complex depended on converting more rent- regulated units to market rates. That's proving a bigger challenge than expected.

The companies, which bought the 80-acre, 11,200-unit Stuyvesant Town-Peter Cooper Village in 2006, are facing higher costs to shift units to market price and less income than forecast from remaining rent-stabilized apartments. Overall expenses have also been higher than anticipated, Standard & Poor's said in a report last week.

``A lot of landlords aren't able to raise their rents right now and I think there is a huge amount of uncertainty given what is happening in the financial markets,'' said Victor Calanog, director of empirical research at New York-based Reis Inc., a real estate research firm. ``There is quite a bit of sentiment right now that a lot of transactions that went through in the last year or two, or even three, were overvalued.''

Tishman and BlackRock are being buffeted by financial challenges as buyers who used loans to finance purchases have buckled under mortgage-related debt. Stuyvesant Town is now worth 10 percent less than what Tishman and BlackRock paid two years ago, S&P said in the Sept. 26 report in which it downgraded ratings on 22 classes of commercial mortgage-backed securities related to the properties.

Low Vacancy Rate

A $3 billion loan to finance the acquisition was bundled with other commercial mortgages and sold in five debt offerings, according to Bloomberg data. S&P has cut more than 3,500 mortgage-related securities, and more than 100 mortgage companies have suspended operations, closed or sold themselves since the start of 2007.

``Given current market conditions, Standard & Poor's is putting particular scrutiny on the loans that have experienced net cash flow declines, and is increasing our expected losses for the loans that we deem to be at increased of risk of default,'' S&P analysts Harris Trifon and Barbara Hoeltz in New York said.

Tishman is confident of the long-term prospects for the properties, spokesman Robert Lawson said in a statement. The complex has an overall vacancy rate of just 2 percent and rents were increased 10 percent over the summer, he said. Tishman and its partners will raise more money for the development as needed, he said.

MetLife Inc., the largest U.S. life insurer, built Stuyvesant Town and Peter Cooper Village in the 1940s with city assistance. New York needed the property, which runs from 14th to 23rd streets on the East Side, to house returning World War II veterans. About 25,000 residents live there today.

$3,400 One-Bedrooms

At Peter Cooper, market-rate one-bedroom apartments start at $3,420 a month and two-bedrooms at $4,775, according to the Web site. At Stuyvesant Town, one-bedrooms begin at $3,055; two- bedrooms at $3,875; and three-bedrooms at $5,215, according to its Web site. Both developments include a note that prices are subject to change.

Al Doyle, president of the Stuyvesant Town-Peter Cooper Village Tenants' Association, has lived there his entire life and pays about $1,400 a month for a rent-stabilized two-bedroom.

When MetLife sold the property in 2006, it estimated residents of 1,600 apartments would move out, die or have their rents reach the $2,000 deregulation threshold by the close of 2008, letting the landlord raise rents by any amount the market would bear. So far, Tishman has only deregulated about 1,000 apartments, according to S&P, 38 percent fewer than MetLife estimated was possible.

Lower Rental Income

Tishman and BlackRock were expecting to convert 64 units monthly, or 6.9 percent annually, according to a Merrill Lynch & Co. report on Sept. 12. The actual conversion rate is about 43 units monthly, or 4.6 percent annually.

The number of conversions was within S&P's own forecast range, the ratings company said, without being more specific. The average rental income at the rent-stabilized units is 10 percent lower than anticipated. The cost of converting regulated units to market-rate has been 11 percent higher than anticipated.

One reason may be the free legal clinic New York City Councilman Daniel Garodnick, a life-long resident of the developments, helped establish to assist tenants fighting eviction.

`Culture of Conflict'

``There is a culture of conflict between the residents and the owner because of a flurry of legal notices that have been sent out to tenants over the last two years challenging their tenancies,'' Garodnick said in an interview. ``Too many of those notices were based on inaccurate facts and too-aggressive tactics.''

Lower cash flow has hurt Tishman and BlackRock's reserves, prompting the S&P downgrade.

A debt service fund established in 2006 with about $400 million now has $165.7 million in it. A general reserve account has fallen to $33 million from $190 million, S&P said.

A $1.5 billion portion of the Stuyvesant Town loan is the largest loan in a $7.9 billion commercial mortgage bond offering sold by Wachovia Corp. in March of last year, according to documents distributed at the time of the sale.

The AAA portion of that sale was trading at about 435 basis points more than benchmark rates earlier this week, as much as 90 basis points wider than benchmark AAA commercial mortgage bonds, according to RBS Greenwich data.

Riverton's Woes

Yields over benchmark rates, or spreads, on commercial mortgage-backed securities widened in late August after the owners of Riverton Apartments in Harlem said they would be unable to make their September interest payments on a loan that used similar projections on converting rent-stabilized apartments. The $225 million loan was packaged into a $6.6 billion commercial real estate bond offering sold in March 2007 by Citigroup Inc. and Deutsche Bank AG.

The borrowers, Rockpoint Group LLC and Stellar Management, burned through a $19 million reserve to cover the interest shortfall, according to an Aug. 15 report from Lehman Brothers Holdings Inc. analysts Aaron Bryson and Tee Yong Chew in New York. The owners have since made the interest payment and are working to modify the terms of the loan, according to S&P.

``In light of the focus on Riverton, it is not surprising the rating agencies would take a closer look at Stuyvesant Town,'' said Kent Born, a senior managing director in the commercial lending group at PPM America Inc. in Chicago, which has more than $72 billion in assets under management. ``They want to be out ahead of the curve in terms of downgrading bonds given all the pressure and scrutiny the rating agencies are currently under.''

To contact the reporters on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net; Sharon L. Lynch in New York at sllynch@bloomberg.net.

Last Updated: October 2, 2008 00:01 EDT