Can The Reichmanns Hang Tough?

In the past, Paul Reichmann almost welcomed recessions, so he could sweep up real estate in New York, Toronto, and elsewhere at bargain prices and expand the sprawling Olympia & York empire. But the current recession in real estate is as dark as the fog that swirled outside his Toronto office on a recent morning. It's "the worst I've seen," he says, in the 30 years since he and his two brothers began building O&Y into the world's leading developer.

That's why, this time around, the last thing on his mind is bottom-fishing. The usually secretive Reichmann admits that O&Y is "suffering in this downturn." Its vast North American holdings are in the black, but Reichmann says that "cash flow is much worse than it was two years ago." The sharpest pain is in London, where O&Y's largest project ever, the $6.5 billion Canary Wharf development, is bogging down. With some buildings still empty, the Reichmanns are behind schedule in recouping their huge upfront costs--$3.1 billion to date. What's more, though he expects a general recovery to begin in six months to a year, Reichmann predicts "real estate markets will remain bad...for two to three years at least."

PENNY-PINCHING. Reichmann's game plan tilts all of O&Y's considerable resources toward the 71-acre Canary Wharf site on London's outskirts. He's calling off plans for new projects and is relying on asset sales of non-real-estate holdings to pump cash into Canary Wharf. And he's pushing to get it at least 80% leased within the six to nine months to help ease the company's cash crunch. Reichmann insists that his vision of creating a new business center for London will ultimately pay off, boosting the value of Canary Wharf to "two to three times what we spent on it."

But even Reichmann, one of the most trusted men in business, is finding that financing projects is much more difficult than ever before. A few years ago, he muses, O&Y "could easily borrow 70% of the costs [of a project] on the bricks and mortar alone," without a single tenant signed up. Today, Reichmann observes, "you can't start thinking about lining it up until 75% of the space is committed."

The penny-pinching climate became painfully evident in mid-January, when a dispute between O&Y and one of Canary Wharf's major tenants, Morgan Stanley & Co., escalated into court action. Morgan Stanley had paid for the construction of its own building, and O&Y had agreed to buy back the building for $240 million. In early 1991, O&Y hired the investment bank to arrange the financing for such a transaction.

Reichmann declines to discuss the matter. But according to Michael Dennis, executive director of Olympia & York Canary Wharf Ltd., "Morgan was telling us they were confident" the financing could be done only a month before the Dec. 12 trigger point in the contract that gave Morgan the option to demand its money. Then, the board of the Japanese institution that was supposed to provide $180 million of the money decided it would only commit $72 million, and the entire deal collapsed.

O&Y executives wanted to postpone the deal. But Morgan says that "it was explicitly agreed that O&Y was not relying on our efforts" to line up financing and that O&Y was "unconditionally" obligated to buy the building under a sale-leaseback deal. Morgan is now suing Olympia & York in London for the $240 million.

O&Y is clearly worried that the public brawl will only further hamper the project's credibility among prospective tenants and already nervous bankers. "A crisis of confidence is the one thing that can screw us up," worries one London insider. Meanwhile, says Dennis, O&Y is already searching for another investment bank and is confident they will arrange a deal--backed by Morgan's credit as the building's lead tenant--before the case ever comes to trial.

Reichmann is anxious to move ahead on financing for other buildings in the vast project. By April, he says, O&Y will have financed the central tower, which is largely leased, through a $540 million private placement with a small group of institutions. Dennis adds that while Canary Wharf is only 57% leased now, O&Y is in talks with four or five major new tenants and expects some signed deals in the next few months.

So far, O&Y has lined up outside financing for only $1.1 billion of its investment in Canary Wharf--in construction loans. The remaining $2 billion came from O&Y's credit lines and asset sales. Since late 1990, O&Y has raised some $1.2 billion by selling Consumers' Gas Co., Canada's largest natural-gas supplier, and its 9% stake in Allied-Lyons PLC. Without those sales, Reichmann admits, "we would have had much more difficulty finding the money."

The New York City slump is adding to woes. The Reichmanns "have to be feeling severe pressure from their downtown buildings" in Manhattan, says Lloyd Lynford of REIS Reports Inc. As downtown vacancy rates have soared to 19%, rental rates have fallen 30% since 1987, Lynford figures. With its top-grade properties, including the fully leased World Financial Center, O&Y has held its downtown vacancy rate to 10%.

METRO LINK. For all this, Reichmann shows a characteristic calm, keeping an eye on the long view. He says he expects to sell O&Y's stake in Interprovincial Pipe Line Co., North America's longest crude-oil pipeline system, this year, figuring it should command full value. Its current market value is more than $600 million. He's hesitating on plans to sell Home Oil Co. in the depressed market "because we have not gone after fire sales." He also plans to keep O&Y's other major industrial interests, worth at least $5 billion, reasoning that such currently depressed holdings as newsprint giant Abitibi-Price Inc. and Gulf Canada Resources Ltd. will eventually revive.

Nor is Reichmann backing off from a planned expansion of Canary Wharf. O&Y has put the lid on any major additional construction, planning to open only five or so "small" buildings between now and 1996. But Reichmann says he's still planning to launch the 1994 phase of Canary Wharf to ready it for the expected 1996 opening of a key transport link, the extension of London subway lines to the project. This phase will cost several billion dollars more.

By then, Reichmann bets that Canary Wharf will be irresistible. "London is the only major city in which two-thirds of the office space is obsolete," he reasons. Reichmann figures today's low interest rates in the U.S. are certain to fuel inflation, sparking a resurgence in real estate by the mid-1990s--and allowing O&Y to boost rents. It's such musings on long-term trends that are Paul Reichmann's trademark. All he has to do now is be right again.

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