Can New York teach Berlin a history lesson?

In 2006 Tishman Speyer and BlackRock Realty teamed up for the largest single-asset real estate transaction in history: the $5.4 billion acquisition of Stuyvesant Town (“Stuy Town”), an 80-acre site on Manhattan’s East Side housing 110 residential buildings, 11,250 apartments and 25,000 residents. Stuy Town was adjacent to the surging East Village, which had evolved into a magnet for the young, creative and hip (this may sound a lot like the marketing for Berlin nowadays).

Tishman and BlackRock loaded-up the acquisition with $4 billion of debt. Incredibly, from Day 1 they were unable to finance the necessary capital improvements and service the debt, so the partnership borrowed another $900 million (!) of expensive mezzanine debt to 1) service the debt interest payments, 2) renovate apartments and 3) undertake common area improvements. Consequently the total cost of the acquisition ballooned up to $6.3 billion. As noted in a 2010 New York Times article, “the two partners were betting that they could turn a healthy profit over time as they replaced rent-regulated residents with tenants willing to pay higher market-rate rents. But their plan fell apart when they could not convert enough apartments to the higher rents as quickly as they had planned.”

So what does this have to do with Berlin today?

The italicized phrase above is critical: the business model was dependent on increasing the churn rate of moving tenants out of rent-regulated units (aka stabilized units) to capture the significant reversion. The problem with this strategy was one which is, in my view, currently starting to afflict Berlin residential: as rents in the surrounding areas increase, the churn rate plummets. Counter-intuitively, the higher the reversion, the worse it is for the business. Typical life events that cause tenants to move, such as marriage and children, actually resulted in residents staying longer in their units as partners moved-in to take advantage of the great deal. It is interesting to consider that this dynamic was occurring in the highly transient city of New York, where residents typically move more frequently than the long-term rental culture of Germany.

In 2010 Tishman, BlackRock and the other equity partners in the deal defaulted on all of the equity in the largest commercial mortgage default in history. While I am not suggesting that the Berlin residential market is on a similarly spectacular path to collapse as there is a lot less leverage in today’s market, the underlying real estate issue is very similar, in my view. Due to surging rental prices, tenant turnover in Berlin is plummeting to c.6% pa in some areas, down from 10%+ a few years ago. It will be interesting to see if lenders, valuers and investors begin to lower their multiples to reflect the lower churn rates, and therefore lower cash flows. So perhaps the new world can provide a history lesson to the old, and the prospect of reversion is viewed with a bit more skepticism...

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Written by: Written by:

Jamie McDevitt