Risky Real Estate Deals Helped Doom Lehman

Significant losses that Lehman Brothers suffered from its part of the acquisition of Archstone-Smith, a national apartment portfolio, helped to bring down the investment bank, one of the most venerable firms on Wall Street.

But the deal, undertaken with Tishman Speyer, was not the only high-risk commercial deal that Lehman sealed weeks, and even months, after ratings agencies warned the real estate industry that underwriting standards had become too lax and rental growth projections too robust.

In July 2007, just as the credit squeeze began, Lehman teamed up with Prologis , a publicly traded logistics company, to buy a national portfolio of warehouses for $1.85 billion from Dermody Properties and the California State Teachers Retirement System. To get the deal done quickly, Lehman not only supplied the debt financing but also provided 80 percent of the equity.


But then Lehman found itself unable to pool the warehouse mortgages with other loans and sell them to investors, said Cedrik Lachance, an analyst for Green Street Advisors, a research company based in Newport Beach, Calif. Nor was it able to find buyers for its equity position.

At the same time, the warehouse industry, whose fortunes depend on a healthy retail industry, began suffering the effects of the economic downturn, “Property values started declining shortly after the deal closed,” said Mr. Lachance, who estimated that the portfolio had lost 15 percent of its worth.

In addition to the industrial portfolio, Lehman was also involved in large office deals in Arlington, Va., in May 2007, and Austin, Tex., in June 2007. By this time, there was already considerable anxiety in the market, prompted by the spate of high-priced deals that occurred after the Blackstone Group, the private equity company, bought the nation’s largest office portfolio, Equity Office Properties, for $39 billion and then began immediately to dismantle it.

That April, Moody’s Investors Service said it would adjust its ratings to reflect a growing concern that lending practices had become too risky.

“Lehman always had a reputation for being one of the most aggressive lenders in the commercial space,” said Robert M. White Jr., the president of Real Capital Analytics, a New York research firm.

One real estate investment broker described Lehman as “the real estate A.T.M.”

“They definitely were the mavericks out there,” said the broker, who did not want to be identified to protect his business relationships. “If you needed money, you could get it.”

Though Lehman reduced its commercial real estate exposure in the third quarter to $32.6 billion, from $39.8 billion, this broker said it was slower than other banks to sell its real estate positions at a discount. Last week, before its announcement that it would file for bankruptcy protection, Lehman said it planned to spin off its real estate assets into a separate company rather than sell them in a depressed market.

Market-wide declines

Lehman has said that 57 percent of its commercial real estate assets are in the United States, with 26 percent in Europe and 17 percent in Asia. Of its real estate positions, debt represents 58 percent and equity, 26 percent. Another 16 percent is in securities. The investment bank did not respond to a request for comment.

Though Lehman may have been quick to finance deals, it did better as a loan originator than some of its competitors, said Frank Innaurato, a managing director of Realpoint, a credit rating agency in Horsham, Pa., that monitors commercial mortgage-backed securities. These are created when mortgages are packaged together and sold to investors as bonds.

For Investors

Of the 2,845 loans that Lehman originated for this bond market, only 0.5 percent are currently listed as delinquent, in line with the average for all the loans backing these securities. Loans originated by Bank of America , for example, have a delinquency rate of 0.7 percent, Mr. Innaurato said. And none of Lehman’s defaulted loans poses a major credit risk, he said.

But Lehman itself continues to hold debt and equity positions that have dropped significantly in value, including several investments that were made after the market peaked.

In October 2007, Lehman joined Tishman Speyer in buying Archstone-Smith, a publicly traded company with about 360 upscale apartment buildings across the country. Lehman put in $250 million in equity and led a group of lenders that contributed $4.6 billion in bridge equity for the $22.2 billion deal, which was financed in part by Fannie Mae and Freddie Mac.

Both Lehman and Tishman Speyer have written down their investment in Archstone by 25 percent. The partners sold a majority interest in 16 apartment buildings when the deal was completed. Since then, they have sold 13 additional Archstone properties, according to Jessica Ruderman, a senior marketing analyst at Real Capital Analytics.

In June 2007, Lehman teamed up with Thomas Partners, a real estate investment trust based in Los Angeles, and the California State Teachers Retirement System in a $1.15 billion deal to buy 10 office buildings, including the new Frost Bank Tower, in Austin, Tex., that Blackstone was flipping from its Equity Office Properties acquisition. By last July, Lehman still had a $1 billion equity and debt investment in the deal, according to Commercial Mortgage Alert, a trade publication.

Lehman and its partners paid an average price of $328 a square foot for the Austin deal. In the last year, however, buyers of office buildings in Austin paid an average of just $221 a square foot, said Mr. White of Real Capital Analytics.

But an Austin broker, Jeff Coddington, a senior vice president of Oxford Commercial, an affiliate of Cushman & Wakefield, said the bulk of the portfolio bought by the Lehman consortium consisted of prime downtown office buildings. “Obviously, you pay a premium for this real estate,” he said.

In another deal that occurred at the peak of the market, Lehman and its partner, Monday Properties, bought 10 office buildings in the Rosslyn section of Arlington, Va., for $1.3 billion. Lehman managed to sell its debt financing, but it continues to own 75 percent of the equity.

Prices in Arlington have declined by about 12 percent, Ms. Ruderman said. “Compared to the rest of the market, that’s not so bad,” she said.