San Francisco's biggest apartment owner has tripped on its financial high-wire act and is racing to secure a safety net.
The closely held Lembi Group recently handed over 51 buildings to
one lender because of nonperforming loans and is now trying to
renegotiate some $1 billion in short-term debt to save dozens more
buildings in its portfolio.
The Lembi Group is viewed as a barometer of San Francisco's
multifamily market, traditionally one of the country's strongest in
terms of occupancy and rent growth. Yet while the group's woes offer
evidence that local rents are softening, the situation more broadly
underscores the pitfalls of using high-leverage financing for
aggressive purchases of rent-regulated properties.
New York's Peter Cooper Village and Stuyvesant Town, which were
bought for $5.4 billion in 2006 by a venture led by Tishman Speyer
Properties and BlackRock Realty Advisors, are among other developments
facing a similar predicament as the Lembi Group. The landlords haven't
been able to replace rent-regulated tenants with those who pay higher,
market rates fast enough to cover their debt costs.
By spending more than $1 billion between 2003 and 2007 and borrowing
up to 95% of a building's purchase price, the Lembi Group became San
Francisco's dominant residential landlord. The group, whose main units
are CitiApartments Inc., Skyline Realty Inc. and Trophy Properties,
amassed a portfolio of 307 buildings and more than 8,000 apartments
across the city.
In recent weeks, the group ceded ownership of 51 buildings, comprising some 1,400 apartments, to UBS
AG through deeds in lieu of foreclosure. Walter Lembi, managing
director of Lembi Group, said the shortfall between income and debt
service on the buildings was $3 million a month. Lembi executives say
they are negotiating with several other lenders to extend close to $1
billion in mortgages, some of which are securitized, that are due to
mature over six to 12 months.
That figure doesn't include a $164 million loan secured by 24
apartment buildings. CIM Group of Los Angeles bought the senior debt
for this portfolio at a discount. The interest reserves, or bank funds
that provide cash flow to help service the loan, recently ran out, says
Mr. Lembi. Mr. Lembi declined to comment on whether CIM has filed a
notice of default. CIM also declined to comment.
The problems represent a reversal of fortune for Mr. Lembi, whose
father started the business in 1946. After a four-year buying binge
that pushed up San Francisco apartment prices, he put up 18 buildings
for sale last year, arousing market suspicion that the group was
overextended. At the time, Mr. Lembi acknowledged he was working to
extend short-term loans but denied he was under pressure to sell.
Mr. Lembi blames his firm's problems on the combination of the
credit crunch and recession, which conspired to make the group's normal
exit strategies -- refinancing or selling -- virtually impossible.
"Because of the disturbance in the marketplace, lenders got nervous and
held back," he says. "Nobody could have predicted this train wreck."
Still, Mr. Lembi's high-leverage strategy, which had worked for
nearly a decade, left little margin for error. His plan was to buy
buildings, induce tenant turnover through buyout offers and other
means, renovate apartments and lease them out at market rates. Key to
his model were the availability of interest reserves until market-rate
tenants could be found and a building could be refinanced with a
longer-term fixed-rate mortgage.
The finances were such that because he borrowed up 95% of a
building's value, Mr. Lembi had to convert about three-quarters of a
building's tenants to market rents during the two-year period of the
interest reserves. But the wheels came off last year: As loans came due
and couldn't be refinanced, the Lembi Group didn't have funds to
complete renovations or pay tenants to move out. The relocation rate
fell far below the 75% target.
At least one lender sold Lembi debt at distressed levels. UBS, the
Lembi Group's largest lender, opted to take possession of 51 buildings
that were collateral for nonperforming loans and hold them until
markets improve. It retained the Lembi Group to manage the buildings
for a fee, citing the firm's "knowledge of the properties and issues
related to the buildings," UBS spokesman Doug Morris says. He didn't
give a timeframe for the arrangement, but added, "We will continually
evaluate the best way to manage the properties and make adjustments as
needed."
Under the terms of the UBS deal, Mr. Lembi says, he is released from
a personal guarantee of about $400 million, but he is subject to other
guarantees that he declined to specify or quantify. Mr. Lembi says he
won't be able to strike a similar deal -- deed in lieu of foreclosure
-- with other lenders because the UBS transaction used up corporate
losses that offset tax liabilities.
The 51 apartment buildings that UBS took over are about 98% occupied
and, now that there are no debt-service payments, they are generating
positive cash flow, according to people familiar with the finances.
Even as San Francisco brokers and landlords report an uptick in
apartment vacancies to between 4% and 5%, along with softening prices,
Mr. Lembi says that occupancy in his remaining 250 buildings remains
robust. Brokerage firm Marcus & Millichap forecasts that San
Francisco will be the most attractive apartment market again in 2009,
though vacancies are expected to rise and rent growth will moderate.
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