NEW YORK (Reuters) - The John Hancock Tower, New England's tallest office building, sold in a foreclosure auction on Tuesday for $660 million, about half what the sellers paid three years ago, underscoring the crumbling state of the U.S. commercial real estate market.
The building, a distinctive presence on the Boston skyline, was bought by Normandy Real Estate Partners and Five Mile Capital Partners, investors that had previously snapped up distressed loans on the property.
The building, designed by renowned architect I.M. Pei and officially named Hancock Place, went into foreclosure in January after its owner, Broadway Partners, defaulted on the mezzanine loans it used to finance the $1.3 billion sale in late 2006.
"This is exactly what is happening with many other buildings across the country," Chris Stanley, an analyst at real estate research firm Reis Inc in New York. "Now that things have started to deteriorate, they will deteriorate at a much faster rate because of all the leverage in the system."
And the trend is expected to get much worse.
Delinquency rates for U.S. commercial properties, which stand between 1.2 percent and 1.8 percent, could rise between 3.5 percent and 5 percent by the end of the year, according to forecasters. The default rate is expected to top that next year.
During the U.S. commercial real estate boom from 2005 through 2007, cheap debt financing enabled investors to snap up property by using as much as 90 percent debt.
Investors paid skyrocketing prices based on very aggressive assumptions that rental rates and occupancy would soar and that they could sell or refinance the property at a much steeper price.
But frozen credit markets sent the U.S. economy foundering, rental rates falling and occupancies dropping as layoffs mounted.
The properties that were priced for perfect conditions are finding they can't survive the current market downturn and are going into default.
"As soon as it stops performing, it makes it much more difficult to service the debt, which is why we're seeing what we are seeing now," Reis' Stanley added.
Added to that, the funding sources that many borrowers plan to use to repay the principal of the loans have dried up, igniting a slew of defaults from borrowers who were otherwise current on their payments.
In the meantime, investors, such Normandy Real Estate Partners and Five Mile Capital Partners, the Hancock building's new owners, have been storing up cash to snap up distressed property.
The Hancock building is one of the most widely photographed features of the Boston skyline, rising 790 feet in a skin of blue glass and steel that reflect the surrounding 19th-century buildings of Boston's Back Bay.
Based in Morristown, New Jersey, Normandy Real Estate Partners manages discretionary real estate funds totaling $1.0 billion of equity commitments.
Five Mile, based in Stamford, Connecticut, is an alternative investment and asset management company, with about $3 billion of assets under management.
In June 2008, the Normandy-Five Mile partnership began buying up mezzanine loans with the intention of purchasing the Hancock building. The mezzanine loans, which the partnership bought at distressed prices, were secured by Broadway's interests in both properties.
The loans gave the partnership the right to become the property's owner if the entities owned by Broadway Partners defaulted, which they did in January.
Normandy and Five Mile were the only bidders at the auction -- part of the foreclosure process -- and bought the Hancock building for $20.1 million, $100,000 above the opening bid, plus the assumption of the $640.6 million mortgage. The $640 million mortgage has been securitized into commercial mortgage-backed securities bonds.
The building is 85 percent occupied, according to Reis. The largest tenants include John Hancock and Ernst & Young.
The partnership also acquired 10 Universal City Plaza in Burbank, California, for $10.1 million and the assumption of the $294.75 million mortgage, for a total of $304.85 million.
Originally built in 1984 as the MCA-Getty Building, 10 Universal City Plaza, a 36-story building, is home to NBC Universal. The largest tenant is Universal Music Group owned by Vivendi SA.
Additional reporting by Jason Szep in Boston; editing by Jeffrey Benkoe