`A Lot More Pain To Come'

Founded on vast optimism and funded by eager lenders, the prestigious Portman real estate realm has foundered in the lousy property market of the '90s. Like other high-flying developers who have come to grief in the past two years, John C. Portman Jr. never figured that demand for his gargantuan projects would flag. But in 1990, massive vacancies forced Portman into a killing cash crunch. He couldn't service the $2.1 billion in debt that had expanded his empire of concrete and glass from his Atlanta hometown all the way to Shanghai.

The woes facing Portman, who declined to be interviewed for this story, are shared by legions of other wounded developers, from New York's Donald Trump to Dallas' Trammell Crow to obscure suburban players. The harsh 19.5% office vacancy rate nationwide also is inflicting pain on the banks, insurance companies, and other financial institutions that lent them the money in the first place (chart). The commercial real estate debacle has been the main reason for the wave of big bank and insurer failures this year.

All this misery has radically altered--and complicated--the once simple dealings between borrowers and lenders. Traditionally passive providers of real estate capital, many lenders in the '90s are finding themselves deeply enmeshed in the actual operations of the buildings they have financed. Loan restructurings used to mean merely stretching out maturities and hoping for the best. Nowadays, restructurings mean close involvement in a project's operation, with strict financial-performance targets.

And if that doesn't succeed, lenders aren't shy anymore about foreclosing. They customarily hated the upkeep hassles of owning property. In the past, if they did end up seizing a building, they would sell it quickly. Now, lenders often hire experts to run the place--for years, if necessary. They have no choice. There is no longer an ever rising real estate market to cure a building's distress, allowing a sale at a tidy gain. Says Kenneth Leventhal, a Portman adviser: "In this market, no one can liquidate."

HARD LINE. Typically these days, lenders and fallen borrowers are finding themselves forced into a continuing and sometimes uneasy partnership. Lenders took control of Portman's holdings--his downtown Atlanta Peachtree Center office complex and nearby Inforum, a computer-merchandise mart--and put him on probation. He has five years to turn his finances around by selling or refinancing $140 million worth of real estate. He can request an extension only if he meets cash-flow goals. Crow, faced with defaulting on dozens of mortgages, was bailed out last year by Equitable Life Assurance Society, which refinanced him with a $456 million loan. One hitch: He had to surrender to them a 45% interest in 65 new buildings. For the brash Trump, the experience with lenders has been more humiliating. Last year, he had to cede control of his hotel, airline, and casino kingdom to them and live on an allowance (a paltry $450,000 per month). Lately, they've been making him divest other prize assets.

The lenders' new hard line is a little ironic: They're like the free-pouring bartender who suddenly becomes a firebrand of temperance. During the sweet times of the past decade, banks were easy marks for a developer with an architectural plan and a rosy-sounding revenue projection. Developers often had to put up very little equity, leaving trusting lenders on the hook for a lot. Says real estate attorney Michael J. Shapiro, a partner with Shereff, Friedman, Hoffman & Goodman in New York: "It seemed that the more zeros you added to your loan request, the less you had to put down."

That's what happened with Citicorp and Portman's 60-story One Peachtree Center in Atlanta, which will open next year but is only 40% leased. In 1989, the nation's largest bank made Portman a $300 million construction loan -- and then lent him $78 million for his equity portion, secured solely by his signature guaranteeing repayment. The bank won't comment. One Citi executive involved in the deal says the bankers thought they could syndicate the construction loan to other lenders, but the public disclosure of Portman's difficulties stopped that.

Lenders and borrowers will be locked in their awkward embrace for a long time. The current real estate market slump, the worst since the '30s, is expected by a wide range of experts to persist for four or five years. Says Arthur J. Mirante II, president of Cushman & Wakefield Inc., a major real estate broker: "We are at the very bottom, with a lot more pain to come." Too much excess space was built in the past decade for demand to absorb soon. That's because, even when the recession ends, there likely won't be a repeat of the surge in white-collar and retail employment that spurred the 1980s construction binge. In fact, Corporate America will remain committed to work-force downsizing. Those pink slips will mean more red ink for real estate.

Just about every region of the country is suffering. The vacancy rate in Portman's Atlanta has soared from 14.3% in 1989 to 19.8% in mid-1991. Manhattan, the largest office market in the nation, is burdened by a 17% rate, with the financial district hit hardest.

The higher the vacancy rates, the more likely the new lender-borrower partnerships will degenerate into strife that leaves both sides bloodied. Take the saga of Citi's $250 million loan to build a 41-story office tower in midtown Manhattan. The place is as empty as interstellar space. The bank foreclosed on 1540 Broadway in April and now is embroiled in a court fight with the owners, who are resisting the seizure. The owners, a partnership led by VMS Realty Partners and developer Bruce Eichner, could not be reached for comment. Legal skirmishing could grind on for a year or more. Even if Citi wins, local real estate brokers say it can only unload the building for $100 million, 60% less than the mortgage.

GRACE NOTE. Worse, lenders sometimes end up squabbling among themselves. By the time he came a cropper last year, the 66-year-old Portman had collected 50-odd lenders. Trust among them ran low. Unsecured lenders Chemical Bank and Germany's DG Bank sued to recover their money. Equitable and Nippon Life Insurance Co. put everyone on edge by cutting a separate deal with Portman: In lieu of loan repayment, they received a 75% stake in Peachtree Center; Equitable bagged 95% of the Inforum computer mart. Finally, after an impassioned plea by a Bank of Nova Scotia representative to work together lest Portman slide into a bankruptcy that would hurt everyone, the lenders agreed to Portman's five-year grace period.

Portman's deal, though, shows that even the most carefully crafted lender-borrower partnerships may not be enough to rescue ailing properties. Portman's future rides mainly on One Peachtree Center, the lone piece of the Peachtree complex in which he owns 100%. Even if it attracts more tenants, the 1.4 million-square-foot building won't get anywhere near the $30-per-square-foot rents envisioned in the project's initial financial projections. Perhaps in anticipation, Citi has written down the value of One Peachtree from $378 million to $270 million, says a key Atlanta real estate figure. The bank won't confirm that.

But there is some good news: Eventually, the market will turn around. New commercial construction is negligible. None of the past decade's lenders, not even the Japanese, want to finance more construction. So the vacancies will be absorbed in the fullness of time, allowing another real estate cycle to begin. But for a developer on a short leash, such as John Portman, that could be a very long wait.

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