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Price points the real dilemma for investors.

Victor Bucchere, a managing director at CBRE Richard Ellis Investors, gave a retelling of his firm's $355 million acquisition of 1540 Broadway in March, one of the only large office buildings to trade in recent months amid a drought in financing.

Speaking at a luncheon held by REBNY's sales brokers committee at the Cornell Club, Bucchere and his colleague Stuart Sziklas, a director at CBRE Investors, recounted how they lowered their offer after discovering discrepancies in financial statements provided by the building's seller to potential buyers.

"There were significant errors that were a result of the lack of continuity (in ownership)," Sziklas said, referring to the succession of owners who have held the property in recent years.

One issue appeared to have to do with mis-stated tenant contributions towards operating expenses, such as electrical charges that registered profits for the landlord that didn't exist. Sziklas clarified that he thought the errors were accidental and not purposeful misrepresentations and that uncovering mistakes of this type were common in sales transactions when the buyer does its due diligence.

When CBRE uncovered that the building's income was lower than initially presented, it dropped its offer to compensate, Sziklas and Bucchere said. That prompted Deutsche Bank, the building's seller, to pull away from the talks in a manner that made it seem as if the bank may have been insulted by the price cut. Negotiations ground to a halt.

Deutsche Bank eventually came back to CBRE and agreed to its $355 million offer, a stark drop from the nearly $1 billion that had been paid for the tower in 2007, at the top of the real estate market.

Originally owned by the media firm Bertelsmann, the roughly one million square foot Times Square skyscraper shuffled among a collection of landlords, first the Paramount Group, then the office REIT Equity Office Properties.

Equity had owned 1540 Broadway for little more than seven months when, in 2007, the Blackstone Group bought the company for $36 billion.

Blackstone proceeded to dismantle Equity's trove of assets in quickly executed, large portfolio sales at the height of the real estate bubble. The firm sold 1540 Broadway as part of a group of seven midtown skyscrapers to the investor Harry Macklowe for over $7 billion in early 2007.

With the economy beginning its descent into a serious recession soon after and the credit markets entering a near total freeze, Macklowe defaulted on the mortgage for the properties about a year later and handed them back to his senior lender, which was Deutsche Bank.

The bank sold off the seven buildings in pairs or in individual sales, but 1540 Broadway lingered on the auction block because of the bank's original plan to sell the tower in a package deal with the jumbo-sized Eighth Avenue office property Worldwide Plaza, another Equity asset that had been purchased by Macklowe and then seized.

Bucchere revealed that CBRE Investors had seriously considered buying the two as part of the initial package offering even though Worldwide came with a high level of risk. One of the building's largest tenants, Ogilvy & Mather, will soon be vacating, leaving behind a huge block of empty space in a leasing market where activity has dramatically slowed.

"It's incredible real estate in a very good although somewhat secondary location," Bucchere said of Worldwide."

It's a deal we liked, although I wish it was smaller. I would have done the deal if it was half the size or less. Our risk profile at that time couldn't take that much risk, that's a big bet. I worked on it countless hours."

1540 Broadway, on the other hand, fit CBRE's investment goals quite nicely, Bucchere said, which is what gave the firm the gumption to close on the deal at a time when few buyers have been willing to make acquisitions because of the widely held belief that asset prices are still falling and that the best discounts are yet to come.

There were a number of indications that the building's sale price represented a bargain deal however. Bucchere said he estimated the building's sale price to be about 40% of the cost of constructing the tower today, a prime method of evaluating value that reflected favorably on their price.

Fewer than 20 percent of the building's leases were set to expire within the next few years, meaning that the tower also appears to have limited exposure to the current dip in leasing.

"All of that made us feel good," Bucchere said. "But can you make money feeling good? We felt we could make money if we could underwrite not leasing space until 2011. No lease up in 2009, we're ignoring 2009 hoping it goes away. We're also underwriting rents that are pretty dam low."

Bucchere said that CBRE Investors was willing to pour money into a deal when most buyers today appear to be huddling cautiously on the sidelines because the firm anticipated the upside that will come when the market rebounds, a light at the end of the tunnel that appears to be lost on many investors amid the gloom.

"I don't think anyone is underwriting recovery," Bucchere said. "Strong growth should return after 2010."

Bucchere said that CBRE plans to hold the building for about five years and produce somewhere just above the firm's usual target of 10 to 14 percent annual returns.

But Bucchere revealed that CBRE purchased the property at just below a 6 percent cap rate, a low initial return that suggests that--discounted purchase price or not--the firm will need his prediction for a 2011 turnaround to come to fruition if it is to expand the building's profits so dramatically into the teens.
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Comment:Price points the real dilemma for investors.
Author:Geiger, Daniel
Publication:Real Estate Weekly
Date:Jun 10, 2009
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