ho ho ho
Giving up the keys to commercial castles
Vacancy rates forcing landlords to turn buildings over to lenders
By Thomas C. Palmer Jr., Globe Staff, 10/14/2003
Some Boston-area commercial property owners are doing what the local real estate market has not seen in more than a decade: turning their vacant and money-losing buildings over to their banks.
A small but rising number of landlords, with suburban office buildings sitting at least half empty, are slowly losing their financial grip as properties generate less income and depreciate in value.
The problem is most severe in the outer suburbs where high-technology job losses have shrunk demand for work space, and vacancy rates in some pockets are at all-time highs that exceed 30 percent.
At least two large property owners have recently given up and turned over their keys to their lenders. And more are expected to do the same before the economy gets much better.
Properties of Boston-based Berkeley Investments at 295 and 305 Foster St. in Littleton, went to auction recently, but no one bought them, so the bank servicing company, Lennar Partners of Miami, took ownership.
"It's sort of a poster child of what's been happening in the 495 area," said a top official of Berkeley Investments, who asked not to be identified. "It was a building 100 percent leased by two tenants. They ended up shrinking to about half the size."
Buildings closer to Boston are not immune, however. In June, Trizec Properties Inc., a publicly held office real-estate investment trust, lost its 192,000-square-foot building at 200 Inner Belt Rd. in Somerville to the lender, Guaranty Bank of Austin, Texas.
"We were going to create a technology or data center," said Rick Matthews, a spokesman for Trizec Properties, known as Trizec Hahn Corp. when it purchased the property for $24 million in 2000. "The market for such properties collapsed very soon after, so it never really got used."
Meanwhile, well-known developer Dean Stratouly could be the next to lose, with his big Wayland Business Center struggling to find tenants.
Stratouly's Congress Group Ventures Inc. bought the 400,000-square-foot building from Raytheon Co. and redeveloped it in 1998, socking about $50 million into improvements. Polaroid Corp. signed a lease to occupy 340,000 square feet -- but then filed for bankruptcy protection in 2001 and vacated the premises last October.
"We only had 12 years to go" on the lease, Stratouly said, employing his own brand of dark humor.
Since Polaroid left, Boston Scientific Corp. had an agreement to buy and occupy the building, but that fell through. Stratouly is now talking to other prospective investors about buying the Wayland complex, which he owns with a partner. Asked whether the building could go back to the bank that holds the note on it, Stratouly said, "It could."
There are dramatic differences, however, between this recession and the one that swept through New England's commercial real estate industry in the early 1990s.
Interest rates have been at historic lows, cutting the costs of financing a building and allowing many owners to refinance. And unusually high leasing rates of the late 1990s provided enough income to shield owners from the injury of months of falling rates.
Also, the lessons of being overextended were learned well. Many buildings were heavily financed in the late 1980s, often built on speculation without any particular tenant signed up. But this time, owners have more of their own money in the buildings, have borrowed less, and have more financial reserves to draw on in the current rainy-day economy. Not least important, this time around most owners have "non-recourse" loans, meaning they can keep their families' summer homes even if their office buildings go belly up.
The buildings that go bust are almost always held not directly by the company that controls their fate but by LLCs, limited liability corporations, or similar structures. So if the company gives up on one empty building, other holdings aren't affected.
"You're dealing with the healthiest real estate industry imaginable, given the downturn," said David I. Begelfer, chief executive of the Massachusetts chapter of the National Association of Office and Industrial Properties. "Values falling, bottom-fishers buying buildings at a discount -- you're not seeing it. People are hanging on to their buildings."
Berkeley Investments, which owned the 180,000-square-foot Foster Street buildings in Littleton, has about 3 million square feet of space nationwide, some 2.3 million in the Boston area. Company officials said the Littleton location is the only one in their portfolio that is in trouble. Berkeley recently purchased 343 Congress St. in Boston for $27 million.
Even the Littleton buildings could have been saved except for some quirky circumstances, Berkeley said. For example, the $11.5 million loan on the $15 million buildings had been converted and sold as commercial mortgage-backed securities. The loan was controlled by a servicing company, and its terms could not be easily adjusted.
Still, most in the industry predict there will be more before it's over.
"Are they on the rise? Yes. You're going to see more auctions" said John T. Kerrigan Jr., senior vice president of Grubb & Ellis Co. "Is it a trend? No."
In fact, the overall statistics are still favorable.
Douglas MacLean, senior vice president of Banknorth Massachusetts, a subsidiary of Banknorth Group Inc. of Portland, Maine, said his institution has seen fewer commercial real estate loans this year that are delinquent more than 90 days, compared with the same period last year.
"The overriding reason is the conservative structuring of transactions by both banks and the developers alike, compared to the last cycle," MacLean said. Owners have at least 20 percent equity in their buildings today, he said, and often much more. "In the last cycle, there was 100 percent leveraging," MacLean said.
Delinquencies on commercial loans held by insurance companies were actually down in the second quarter of 2003 nationwide, to 3.5 percent from 4 percent in the first quarter. In New England, they are 0.01 percent, the lowest of any region in the country, and down from 0.07 percent in the first quarter.
"We are starting to see some people give their keys back," said Richard W. Reynolds, principal and managing director of capital at Spaulding & Slye Colliers. But he and others said that's a typical sign that the economy is bottoming out, and it doesn't mean a cascade of bankruptcies or foreclosures will follow.
"We're going to see more of that, but it's not going to be like 1992," Reynolds said. "We're bouncing along the bottom."
Thomas C. Palmer Jr. can be reached at tpalmer@globe.com.
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