10.19.08

The New Disaster at Lehman

Real estate projects across the country are frozen thanks to the Lehman Bros. bankruptcy.

The Lehman Bros. collapse has roiled through the banks, seizing up the credit flows that are the foundation of global finance. But there's more to come. The investment bank was a major lender and investor in American real estate. With Lehman now locked in bankruptcy, many of these deals don't have the financing to complete construction, meet lease obligations, or pay vendors or complete sales, raising the prospect of a wave of lawsuits and defaults.

Lawyers representing some 2,400 real estate projects across the country are expected to start filing suits over the next several days in a bid to access their financing, lawyers and real estate developers said.

‘The decision backup is enormous. It is like taking the Los Angeles freeway and putting in a red light in the middle of rush hour.’

The bank's Chapter 11 filing provides it protection from any attempts to collect funds under a so-called automatic stay. The court has just appointed a firm to begin the process of looking into these deals. Yet it's already been a month and it's likely to take several more before it can wade through the projects and untangle the financing.

"These cases are ultimately going to litigation in the next 24, 48, 72 hours," the chairman of the real estate department at law firm Schulte Roth & Zabel, Jeffrey Lenobel, said. He is preparing two suits on behalf of clients who hope to reclaim millions of dollars worth of Lehman construction loans.

"There are projects where they have already completed pre-development and the demolition, and are ready to start the actual conversions, but the bank disappeared," Lenobel said. "They have no income yet from the property, but they still have to pay real estate taxes, insurance, their staff, and now the expenses of extending their construction schedule. How long are they supposed to carry this for?"

There are two types of deals that are stuck: residential conversions where Lehman was the lender and the developers now find themselves with half-demolished buildings without access to financing to finish them; and a slew of office towers where Lehman was a part owner and had agreed to fund tenant improvements and broker commissions. In those cases, landlords are fretting that without the funds to complete their obligations, tenants might balk and walk away from their leasing deals, exacerbating an already tough real estate market.

Developer Kent Swig is one of the most visible of the developers struggling in the aftermath of the Lehman bankruptcy. The New York City builder recently suspended sales at 25 Broad St., a circa 1902 office building in Manhattan's financial district that he is converting into 346 residential units. Despite the fact 40 percent of the units are already sold, Swig had to suspend additional sales because he is unable to obtain the necessary approvals from Lehman, including the Declaration of Condominium, which details the ownership rights for the buyers.

"There are 2,000 loans sitting in bankruptcy court, and behind each loan are thousands of decisions that need to be made every day, and there is nobody to make them," Swig said. "The decision backup is enormous. It is like taking the Los Angeles freeway and putting in a red light in the middle of rush hour, and then asking a single policeman to check every car's identification and registration. Even the side streets will get backed up."

It isn't just those projects with direct ties to Lehman that are feeling the impact: There are vendors that aren't getting paid fees for work already completed. In Swig's case, Nova Development Group, a New Jersey-based company that provided asbestos abatement to 25 Broad St., filed a suit in Manhattan State Supreme Court last week, seeking $764,100 from Swig for work done between February and July. Swig has blamed the lack of payment on his inability to access his Lehman loan.

But a project in which Lehman Bros. is a partner is not necessarily a death knell, real estate insiders say. In many cases, Lehman was a limited partner, with equity in the building but no immediate decision-making or funding role. In these cases, the bank's collapse may have minimal impact.

Monday Properties, for example, partnered with Lehman on its purchase of 230 Park Ave., as well as two office buildings in Arlington, Va. In these cases, Lehman has no direct role in the leasing or ownership decisions except any large lease or major capital improvement plan. In those cases, an asset management company acting on behalf of Lehman has been stepping in to make decisions, keeping the operations of the properties flowing, according to sources familiar with the situation.

Still, exposure to Lehman is resulting in negative perceptions. "If you are a company choosing where to go, you might not want to go to a building where Lehman is an owner, because no one knows what is going to happen," Lenoble said. "In this leasing environment, you don't want to give a tenant any reason not to come to your building."