The Times on a Real Estate Deal Gone (Deservedly) Bad

The New York Times on page one today looks at the fate of the buyout of Manhattan’s Stuyvesant Town and Peter Cooper Village. It’s about as close as a story will get to saying: It’s going bust in five months or less.

And it couldn’t happen to a nicer couple of companies.

Stuy Town and Peter Cooper are a kind of middle-class haven on the east side of Manhattan—one that New York commercial real estate giant Tishman Speyer and money manager BlackRock wanted to turn into yet another Manhattan playground for the rich.

They paid $6.3 billion (including a $900 million reserve fund) for the properties three years ago in what was one of the signal moments of the peak of a commercial real estate bubble. The villages sold for perhaps the lowest return—the so-called capitalization rate—ever for a major commercial property in the U.S., a stark-raving mad 2 percent or so. The real cap rate was 1.8 percent by my calculations if you include the reserve fund, which you should. That’s about one third of the national average for apartment buildings at the time.

That meant Tishman and BlackRock were losing lots of money every month, because their cashflow didn’t come close to covering their interest payments (something called negative leverage). So why’d they buy it?

Because they thought they could make the numbers meet by kicking out the middle-class tenants who’d been there all along—many of whom were paying stabilized rents—and turn them over to richer people. Everybody knew this. The press knew it, the tenants knew it, and Mayor Bloomberg, who turned down a $4 billion offer from the tenants themselves, knew it.

That’s why it’s seriously irksome that the Times lets the Bloomberg administration spin away that it’s looking out for middle-class interests, as opposed to the mayor’s dinner partners:

City officials have been monitoring the looming crisis and how it might affect a complex that has served as an oasis of affordability in Manhattan for middle-class New Yorkers. Some 6,875 of the 11,227 apartments at the complexes are rent regulated.

“We are absolutely keeping an eye on it,” said Rafael E. Cestero, the city’s housing commissioner. “It’s an iconic complex.”

But there is some justice in the universe. The Times reports that the complex is now worth less than 40 percent (for some reason the paper doesn’t calculate that number itself, instead using an imprecise “less than half”) of the $5.4 billion purchase price—some $2.1 billion, a nice scoop for reporter Charlie Bagli. And if you use the $6.3 billion number, it’s worth just a third of what they originally paid.

Why’s that? Well, demand for real estate has fallen off a cliff, pushing down prices, of course. But the immediate problem on this deal is that rents in the complex are down 25 percent, an incredible number, especially considering Tishman Speyer needed rents to go up at least 33 percent just to break even. The Times reports that cashflow from the complex isn’t even covering half the debt service. And that’s even with Tishman and the previous landlord already having kicked out several thousand tenants illegally. That ignominy could cost another $200 million, according to the Times.

Of course, this was in the head-I-win-tails-I-don’t-lose economy, so Tishman Speyer only put in $56 million of its own money. That will never be seen again. Neither will most of the lenders’ money.

This one catastrophic deal neatly encapsulates so much of what went wrong in the high bubble era. And Bagli is good not to let the Speyers (who run the company) get their spin in unchecked.

Tishman is also playing deadbeat on two other major purchases, according to the Times—a Washington, D.C., office-building chain it purchased and Archstone-Smith, the giant apartment company it agreed to buy in late May of 2007, also with negative leverage, well after it was clear the bubble was bursting.

You know, it always amazes me when people talk about the government being unable to run businesses. In the health care debate warnings against a public option very often include something to the effect of “Do you want your health care run like the post office or the DMV?”

To which I’d say: Do you want your capital-allocation system run by the likes of Tishman Speyer, BlackRock, and Wachovia?

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.