Chicago Rebound Wins Wilpons 3-Year Reprieve: Mortgages

Rebounding Chicago Saves Office Investors From Brink: Mortgages
Lenders and loan servicers are responding to evidence that Chicago is a market on the mend. Photographer: Saul Loeb/AFP via Getty Images

Chicago’s commercial real estate market is pulling out of a five-year slump, just in time to win some investors who bought at the peak a reprieve on their debts.

Sterling American Property Inc., the real estate firm controlled by Fred Wilpon and Saul Katz, owners of the New York Mets baseball team, was given more time to pay the balance of a $100 million mortgage on 200 W. Adams St. a Chicago office tower they bought in 2006. Bondholders who controlled the debt agreed to extend Sterling’s five-year loan for as long as another three years, said Anthony Sferrazza, Sterling’s finance director.

“Values have escalated for investors and that has allowed people to not only hold on, but probably be in the money when they go to sell,” Paul Lundstedt, executive vice president in Chicago for broker CBRE Group Inc., said in a telephone interview.

The most visible sign of recovery will come this year as construction begins on River Point, a $300 million, 45-story office tower on the Chicago River at Lake Street. The city’s biggest real estate project since 2007 comes after office vacancies fell to 14.6 percent in the second quarter from the 15.9 percent peak at the beginning of 2010, according to data compiled by CoStar Group Inc.’s Property and Portfolio Research.

Hines, a Houston-based property investor, and Ivanhoe Cambridge, the Montreal-based real estate operation of Caisse de Depot et Placement du Quebec, Canada’s biggest pension-fund manager, are developing the office tower. River Point, with 900,000 square feet (84,000 square meters) of space, will be Chicago’s biggest real estate project started in the past five years, Mayor Rahm Emanuel said in a statement announcing the project in May. Construction is scheduled to start before the end of 2012, with completion in 2016.

‘Largely Leased’

“There’s no doubt in our mind that we’ll be largely leased up prior to the completion of the project,” said Greg Van Schaack, senior managing director at Hines in Chicago.

Sales volume for office properties in the city more than doubled in the first half of the year to $1.4 billion from the year earlier period, according to Real Capital Analytics Inc., while Google Inc.’s Motorola Mobility said last week that it will rent almost 600,000 square feet downtown.

“Downtown Chicago is in a good position in that Mayor Emanuel has been aggressively recruiting firms to move downtown,” Van Schaack said. “The city has attracted a vast number of young college-educated graduates.”

Chicago Mending

Lenders and loan servicers are responding to evidence that Chicago is a market on the mend.

Sterling and partner Lincoln Property Co. bought 200 W. Adams St. in downtown Chicago for $113.8 million near the market peak.

Sterling, based in Great Neck, New York, harbored ambitions to invest more than $3 billion in U.S. real estate at that time. Then the market turned on them.

When the venture acquired West Adams “it was a different market altogether,” Sferrazza said in a telephone interview. As the $100 million loan approached maturity, “it was going to be difficult to refinance at best,” Sferrazza said, and the debt was put into special servicing to work out a deal. Firms like CWCapital Asset Management, which is the special servicer on the debt, are companies that negotiate with landlords on behalf of bondholders and decide whether to modify a loan or foreclose.

The loan was included in a $6.6 billion commercial mortgage-backed bond issued in 2007 arranged by Citigroup Inc. and Deutsche Bank AG. Having as many as three years extra on the mortgage’s maturity opens options, including time for a sale, said Sferrazza.

‘Poster Child’

“This is your poster child for a deal that was done at the peak of the market,” said Steve Kuritz, senior vice president with Morningstar Inc.’s structured credit rating group in Horsham, Pennsylvania. “It’s not a bad asset. It’s not a bad market. It’s just a matter of too much leverage.”

The delinquency rate for Chicago area office loans packaged and sold in bonds stands at 7.3 percent. That’s worse than last year’s rate of 5.1 percent, though better than the 10.7 percent rate nationally, according to data compiled by Bloomberg and Trepp Inc.

The extension helps a group of investors beset by financial stress. The Mets owners in March sold minority stakes in the team for $240 million and used the sales to repay $65 million in loans from Major League Baseball and Bank of America Corp. and at least $100 million of debt.

Wilpon and Katz in March also agreed to pay $162 million to settle a lawsuit from Irving Picard, the trustee liquidating Bernard Madoff’s defunct firm, who had alleged the Mets’ owners blinded themselves to Madoff’s Ponzi scheme because it benefited their businesses. As part of the agreement, Picard dropped that allegation.

Holds Promise

Sterling’s principals think Chicago holds promise. The CMBS delinquency rate is well below other office markets in the country. The highest rate in July was in the Atlanta region, whose rate of payments 30 days late or more was 36 percent, followed by Phoenix at 28 percent.

Sales of office buildings in Chicago rose 23 percent to $3.4 billion in 2011 from the prior year, the most since 2007, according to data from Real Capital, a real estate sales data provider.

Demand since the recession ended has centered on the newest towers that are well-leased, as investors sought the safety of the steady cash flow from stable tenants with good credit in so-called Class A buildings. As fewer of the Class A buildings are available, investors are now increasingly buying older buildings with higher vacancy rates, properties known as Class B or C towers. Many of the office buildings that have traded this year downtown have been in that group, according to data from Chicago-based broker MB Real Estate Services LLC.

SEB Acquires

John Hancock Real Estate, the U.S. unit of Manulife Financial Corp.’s property arm, bought 150 N. Michigan Ave., a 41-story Class B building for $102 million, or $154 a square foot, in April, downtown. The diamond-roofed tower overlooks Millennium Park and has views of Lake Michigan. The building, built in 1984, was sold by SEB Investment GmbH, a real estate fund manager based in Germany, according to an April 30 Manulife statement.

“Downtown, the activity continues to be very strong,” Lundstedt said. “Because we had a flurry of higher quality assets that traded in the past few years you’ve started to see some of the class B assets being tested in the market.”

Capitalization Rates

Capitalization rates, a measure of returns for real estate investors, are falling as values gain. Cap rates -- a property’s net operating income divided by its purchase price -- dropped to 7.7 percent in Chicago for office buildings in the first quarter, down from a high of 9 percent in the first quarter of 2010, according to Reis Inc., a New York-based data provider. The cap rate for office buildings in San Francisco was 6.5 percent in the first quarter, Reis said. In Manhattan, the average was 5.3 percent this year through May, according to Real Capital.

Chicago’s effective rent, what a tenant pays after any landlord discounts, was $21.21 per square foot in the first quarter, up from $20.89 a year earlier, according to Reis.

In the West Loop part of downtown, which is closest to the two commuter rail hubs, the vacancy rate was 14.8 percent in the first quarter with rents of $33.49 per square foot, according to broker Colliers International.

Rents Improving

“Rents are starting to improve,” said Glen Marker, a senior market adviser with CoStar’s Property & Portfolio Research in Chicago.

Effective rents in Chicago gained 1.5 percent in the first quarter from a year earlier, while in San Francisco rents rose 6.7 percent over the same period, according to Reis.

The Chicago area’s employment numbers are improving even as they lag behind other areas of the country and the nation as a whole. Chicago’s unemployment rate was 8.5 percent in May, the latest data available, compared with a June rate of 8.2 percent for the U.S.

“We have added jobs in the metropolitan area,” James Kutill, a vice president of Chicago-based Appraisal Research Counselors, said in a telephone interview. “It hasn’t been a boom, but we have added employment.”

Technology companies, such as GrubHub Inc., a closely held online restaurant delivery service based in Chicago, have led leasing expansions this year downtown, according to a Colliers first-quarter market report.

Google Moves

Google’s Motorola Mobility said on July 26 it plans to move the unit’s headquarters from suburban Libertyville, Illinois, to Vornado Realty Trust’s Merchandise Mart downtown and lease almost 600,000 square feet on the top four floors and rooftop of the building. The 4.2 million-square-foot Merchandise Mart, completed in 1930, is the world’s largest commercial building, according to its website.

“It’s a diversified economy,” John Robertson, managing director, head of global securities for Deutsche Bank AG’s RREEF unit, said in a telephone interview. “You don’t have the risk around a particular industry.”

Risks do remain in the market for office space amid concerns over U.S. growth and the effects of the European debt crisis on the global economy. The Federal Reserve reduced its economic growth forecast on June 20 for the U.S. to 1.9 percent to 2.4 percent for 2012, compared with its previous forecast of 2.4 percent to 2.9 percent.

“There’s a certain amount of trepidation,” Kutill said of the Chicago market.

Zell Ownership

Sterling still likes its property in Chicago. The West Adams tower is 88 percent occupied, led by the U.S. General Services Administration, according to data compiled by Bloomberg. It was appraised at $100 million in December, down from $123.5 million in November 2006. It has about 677,000 square feet of space.

The building, once owned by billionaire investor Sam Zell’s Equity Office Properties Trust, was purchased with a loan originated by Royal Bank of Canada, according to a prospectus for the CMBS issue. It was 90 percent occupied when Sterling bought it.

The property is in the West Loop part of downtown, probably the best sub-market in the city, said Kuritz of Morningstar’s structured credit rating group. It’s about a block from a Chicago Transit Authority train stop and is near the city’s two commuter railroad stations.

Back in 2006 when the deal was done, “properties were hot potatoes” and investors planned to hold onto buildings for a limited time and sell quickly to a profit, Kuritz said.

For now, there are no such plans.

“We’re very comfortable with the asset,” said Sferrazza, who led the negotiations with CWCapital.

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