New owner taking over Water Garden.

J.P. Morgan unit to buy mortgage, gain control

In the biggest L.A. office property purchase so far in the 1990s, a real estate investment fund affiliated with New York banking firm J.P. Morgan & Co. Inc. is buying a controlling interest in the first phase of Santa Monica's Water Garden complex, real estate sources confirmed last week.

The total value of the complicated "recapitalization" deal appears to be more than $190 million - or in excess of $285 per square foot of office space. That is a valuation level L.A. hasn't seen for several years.

The key $166 million component of the transaction has a real estate fund managed by J.P. Morgan Investment Management Inc. purchasing the big mortgage on the property - at a substantial discount from its current balance - and converting the mortgage into equity in a new partnership with the developer.

Sources said the fund is paying a lender consortium headed by Bank of America and Citicorp Real Estate Inc. about $166 million for the mortgage, which is thought to carry a balance far in excess of $200 million.

The 666,000-square-foot first phase's current sole owner - a partnership headed by billionaire investor Marvin Davis and local developer Jerry Snyder - is contributing its ownership interest to obtain an unspecified minority stake in the new partnership.

(Snyder is also a partner in Water Garden's similarly sized second phase, which is not yet under construction. Davis interests have held a controlling stake in the 4-year-old first phase, at 2425 W. Olympic Blvd., but are not involved in the planned phase two.)

In order to close the deal, sources noted, Davis is also paying the BofA/Citicorp lender group about $25 million. Davis is said to have actually pledged $40 million as a personal guaranty that the big mortgage loan would be repaid in its entirety - hence, the mortgage lenders are apparently taking a substantial discount on that front as well.

While title records do refer to a "Repayment Guaranty" executed by "the Davis Guarantors," Davis' top real estate executive declined to comment on the guaranty issue.

The Morgan all-cash investment combined with Davis' guaranty-related payment brings the total recapitalization to more than $190 million.

A Morgan spokesman wouldn't comment on the transaction, which was being finalized as the Business Journal went to press late last week. But knowledgeable sources identified the Morgan group as the buyer of the mortgage on Water Garden's six-story, two-building first phase.

The BofA/Citicorp consortium had funded phase one's $230 million construction/permanent loan in 1989 - when Westside office property values were substantially higher than now.

Mike Colleran, the executive overseeing the real estate interests of Davis' Century City-based Davis Cos. holding company. would only confirm that an "institutional investor" is purchasing the Water Garden mortgage and contributing that stake as equity in a "recapitalized" partnership.

Colleran explained that Citicorp and BofA had pursued a sale of the mortgage, and had received bids comparable to the successful buyer's from at least two other institutionally backed investment groups. He added that the recapitalized ownership will carry no mortgage debt.

Davis, Snyder stay in

Colleran also stressed that Davis and associates will retain a "significant interest" - which he declined to specify - in the property and its ongoing asset management. Snyder and other partners in his J.H. Snyder Co. will have "a lesser interest subordinated to ours," he added.

Real estate sources noted that the per-square-foot price at which the Morgan group is apparently valuing the six-story project - perhaps $290 - is the highest any L.A.-area office property has fetched in several years. Nevertheless, the Morgan group can expect immediate annual "cash-on-cash" returns of al least 8 percent, and perhaps 10 percent or more, sources calculated.

The project's high quality, costly land and waterscaping and preferred location certainly influenced the pricing. As presumably did the first phase's 98-plus percent occupancy rate - including major long-term commitments by the likes of high-tech firms Candle Corp. and Microsoft Corp., and law firm Haight Brown & Bonesteel.

Water Garden Associates, a California general partnership headed by Davis, Snyder and their respective real estate investment/development partners, completed Water Garden's first phase in late 1991. More than half the space had been leased shortly after the opening, with Candle and Haight Brown signing the biggest commitments at what some then called "aggressive" lease rates.

In October 1992, the partnership was restructured, with a Delaware limited partnership - also called Water Garden Associates - formally becoming the owner. The modification is said to have boosted Davis' equity interest in the property at Snyder's expense.

The BofA/Citicorp loan was also amended at that time, with its maturity date extended from June 30, 1992, to June 30, 1999. Sources indicated that the lenders also agreed to lower the loan's interest rate.

Some sources suggested that Water Garden Associates has been facing a "negative cash flow" situation as current rental revenues aren't covering both the debt service and the project's overall operating costs.

Others, however, noted that many of the earliest major leases have escalated to higher rates - and that any cash flow deficiencies are negligible.