Stuytown bid set for controversy

By Joy Wiltermuth

NEW YORK, May 16 (IFR) - Fortress Investment Group's US$4.7bn bid for a prime piece of Manhattan real estate is being closely watched for missteps that could land the company in court.

Fortress has its eyes on the 11,000-apartment complex of Peter Cooper Village & Stuyvesant Town, which was at the center of a US$3bn default just five years ago - the biggest default so far in the commercial mortgage bond market.

But the deal looks tricky from the outset because a foreclosure of a junior lien on the property is needed via Fortress affiliate CWCapital before any new owner takes over.

Special servicer CW has overseen Stuytown (for a fee of roughly US$600,000 a month) since its default. In that role, it has so far resisted offers from others to buy the property, saying it can recoup the most value for bondholders through managing the property.

Now it could be poised to give parent company Fortress the inside track.

FAIR VALUE?

CW is expected to use a contentious clause in the original 2006 financing, called the fair value purchase option, to make a quick sale of the defaulted senior mortgage to Fortress. These clauses have fallen out of use in CMBS deal documents due to conflicts of interest.

In the most severe example, the option can mean a trust sells a loan to a deal's controlling class or special servicer at a deep discount, without it being broadly marketed to recoup the most value. At other times, the option allows a trust to give a potential investor a first bid, but bondholders still end up being repaid at par.

"[CW has] done a number of fair value actions in the past," an attorney said. Even so, he added, there would be no safe way to inoculate CW from criticism, or even litigation, if Stuytown were to be sold in such a manner - especially as there was so much money at stake.

"This could be a war," he said.

If Fortress does prevail, one lender said, as many as six money-center banks with CMBS conduits might need to pitch in US$500m parcels to reach a new US$3bn first mortgage.

Fortress could also qualify for financing starting at US$2bn from one of the government-sponsored entities such as Freddie Mac, two bankers familiar with the situation said.

Rising rents in the complex have boosted net income from US$132.8m in 2011 to an expected US$192.2m this year, according to a Barclays report in early May.

Still, a US$4.7bn sale would require the conversion of rent-stabilized units to high prices in order to make the numbers work, said Daniel Alpert, managing partner at Westwood Capital, a firm that had considered buying the property after it defaulted.

"At that price, you can't justify it as a rental project or assume that stabilized insiders will buy many units in a conversion. You are back to square one with the tenants," he said.

And other prickly issues, including a vocal tenant base and a property that is ageing, have all led the former lender to estimate the site's worth at closer to US$3.5bn.

"What would you pay for all of that agony?" Alpert said.

Tenants are still considering a joint bid with Brookfield Asset Management to buy the property, but to preserve it as a home for working-class and middle-income tenants, said Daniel Gorodnick, a member of New York's city council who lives in the complex.

"We will resist any business plan that to be successful must include pushing rent-stabilised tenants out the door," he said.

CREDIT BID LIKELY

CW is likely to make a credit bid at foreclosure for the second lien. To do so, it could tap an estimated US$500m it holds on another junior slice of debt on Stuytown, which it scooped up in 2010 for just US$45m, a person in the original lender group said.

Tishman Speyer and BlackRock used US$3bn of CMBS as part of the US$5.4bn financing to acquire the site at the height of the US real estate boom in 2006. But high leverage and a failed business plan to convert some of the affordable-housing units landed the US$3bn first mortgage in default.

The soured deal also wiped out US$1bn in equity and pushed the holders of US$1.4bn in subordinate liens to settle out of court on their losses.

The latter is where CW and the US$45m could come back into play. If CW borrowed the US$45m from the trust - a conventional route taken in CMBS workouts - then the trust would usually be entitled to any upside, a second person said.

"If you don't put extra value back in the trust, someone is going to sue," he added.

Public notice of the foreclosure is expected in June, a CW official confirmed, but declined to comment further on its plans. Once complete, it paves the way for the Stuytown sale.

(Reporting by Joy Wiltermuth; Editing by Matthew Davies and Anil Mayre)