Goldman's New York Story?

Maura Webber Sadovi of the WSJ reports, Goldman's New York Story:

Seven years after paying $215 million for Manhattan's Park Central Hotel, a venture of Goldman Sachs Group Inc. has sold the 934-room property for $396 million to LaSalle Hotel Properties.

Sounds like a happy ending, right? Well it was for the Goldman venture, but not for some of the lenders that became involved in the deal.

Riding the real-estate boom, Goldman piled $465 million of debt on the 1920s-era hotel near Carnegie Hall. That enabled Goldman to take out all its equity and at least $150 million in profit, people familiar with the deal said.

But the debt was based on what turned out to be an overexuberant valuation. The Park Central continued to generate enough cash to stay current on debt service thanks to the fact that much of its debt had a low adjustable rate. But the music ended when all the debt came due last year, and the Goldman venture wasn't able to pay off all the creditors from the sale.

Similar scenarios are expected to play out this year, especially with commercial borrowers who, like homeowners that took out huge second mortgages, used lofty valuations to overleverage their real estate.

"A lot of properties have pretty significant amounts of subordinate debt," said Harris Trifon, global head of commercial-debt real-estate research with Deutsche Bank Securities Inc. "There's just too much of it."

The story of the Park Central sale also has an intriguing subplot. One of its junior creditors that is getting paid much less than the face value of its debt, Rockpoint Group LLC of Boston, actually is making more than $70 million on the deal. That is because Rockpoint paid an average of 30 cents on the dollar for its $215 million chunk of debt in 2010. The payoff is over 60 cents.

The Park Central deal dates to 2004, when a venture of Goldman's Whitehall Real Estate Funds purchased the building for $215 million and invested about $15 million upgrading the rooms and lobby. Goldman's partner, Highgate Holdings, helped raise the hotel's occupancy rates, and by 2006 Goldman was able to reappraise the building for $594 million, more than double Goldman's purchase price.

That enabled Goldman to put $465 million in debt on the property, including the $203 million that was sold as commercial mortgage-backed securities with an adjustable rate; a $32 million slice of junior debt held by Rheinland-Pfalz Bank of Germany; about $60.7 million in junior debt held by a joint venture of Winthrop Realty Trust of Boston, Inland American Real Estate Trust Inc. and Lexington Realty Trust; and $111.3 million held by a subsidiary of Canadian pension manager Caisse de dépôt et placement du Québec.

An unidentified hedge fund also held about $43 million in mezzanine debt, while KBS REIT held $15 million in mezzanine debt.

When the downturn hit and values tumbled, it became clear to creditors that losses were on the horizon. The Winthrop venture, Caisse de dépôt and the hedge-fund lender were the first to bail, selling all their chunks of debt to Rockpoint for an average of 30 cents on the dollar, according to people familiar with the deal.

Peter Braverman, executive vice president of Winthrop, said the more-senior debt his company owned was sold for significantly more than 30 cents on the dollar. Caisse de dépôt confirmed it sold debt in 2010 but declined to comment further.

Other debt holders fared better. The proceeds of last month's sale repaid at 100% the holders of about $203 million in securitized debt as well as a $32 million slice of junior debt held by Rheinland-Pfalz Bank, according to people familiar with the deal. KBS didn't fare as well: It was repaid about $7 million for its $15 mezzanine position.

Manhattan hotel values are clearly below the records they hit during the boom years. But the New York market is outperforming those in other parts of the country.

In the 12 months through the third quarter of 2011, the price per hotel room acquired in Manhattan rose 20% from the year-earlier period to $440,454, according to real-estate research firm Real Capital Analytics. The peak price was $628,815 paid in the fourth quarter of 2006,

"It's a bet on New York," said Thomas McConnell, co-head of the hotel group at Cushman & Wakefield. "It shows that public companies think things are good enough to make a go of it."

So why did the Caisse bail and sell their chunks of debt to Rockpoint for an average of 30 cents on the dollar? Because they ran into liquidity issues. The full story of the Caisse's $40 billion train wreck has yet to be told, but the simple truth is that the damage from their exposure to non-bank asset backed commercial paper (ABCP) was huge. A lot of stupid decisions were made by the Caisse's previous leaders, including selling real estate debt at bargain basement prices.

Whenever there are big market dislocations, especially in real estate and private equity, there are opportunities for people to capitalize and make a killing. Buying New York real estate debt at 30 cents on the dollar and waiting for a recovery is sweet. Real estate funds had an excellent year last year and while U.S. commercial real estate values are drifting sideways after a two-year rally, I think that improving labor markets will help bolster this sector.

Below, Steve Hentschel, managing director and head of Real Estate Banking, Gleacher & Co., discusses why he thinks commercial real estate trends and issues that were prevalent in 2011 will continue into 2012. I also embedded an interview with Steve Leblanc, senior managing director of private markets at Teacher Retirement System of Texas. He has more of an appetite for risk, putting on more risk in US equities and opportunistic real estate investments.