With credit as scarce as flecks of gold in a prospector's pan, 2008 was a lean year for mega deals. Commercial real estate investment sales shrank by up to 70% in 2008 compared with the $524 billion in deals completed in 2007. Many of this year's top transactions were forced sales as Manhattan's Harry Macklowe became the poster child for a particularly rough year.

Macklowe, the developer who cobbled together a highly leveraged portfolio glittering with trophy assets including the General Motors Building at 767 Fifth Avenue in New York, lost the properties, including those he had bought just a year earlier from Chicago-based Equity Office Properties Trust, after he defaulted on nearly $7 billion in loans. Deutsche Bank seized the assets in February.

When the final numbers are counted, 2008 commercial real estate sales could total only $150 billion. The top deal, the $2.8 billion sale of the GM building, was a far cry from the astral $39 billion that New York-based The Blackstone Group paid in 2007 for Equity Office Properties, triggering the largest real estate privatization in U.S. history.

The smallest deal among the Top 10 was the $888 million the Abu Dhabi Investment Authority paid for a 90% stake in the Chrysler Building, the iconic, 77-story tower in Manhattan.

Only one of the new Top 10 deals was a retail transaction. Real estate advisers say potential shopping center investors are hanging back, fearful that additional major retailers may declare bankruptcy after the holiday season. The investors are waiting until the first quarter of 2009 before making purchase decisions.

Macklowe Properties' forced sales had the dubious distinction of occupying three spots on the 2008 Top 10 list of mega deals. “The dollar value of his acquisitions was so tremendous, I certainly do think he could be the poster child,” says Dan Fasulo, managing director of Manhattan-based research firm Real Capital Analytics (RCA). The firm compiles an annual Top 10 list based on commercial real estate sales of at least $2.5 million.

The most expensive of the three portfolio segments sold by Macklowe and Fortress Investment Group included the GM Building. The agreement with buyer Boston Properties, aided by Goldman Sachs and Dubai-based Meraas Capital, called for a total portfolio investment of $3.95 billion, with nearly $1.5 billion in cash. The deal included a 39-story building on Madison Avenue, Two Grand Central Tower and a building on West 55th Street.

The default was a stunning reversal for Macklowe, who has stepped down as chairman and CEO of the company; his son William now runs day-to-day operations. “He's very lucky he didn't get personally wiped out,” says Fasulo. “Hopefully he's got one yacht left and is riding off into the sunset.”

New York-based Paramount Group and Allianz Life Insurance Co., based in Minneapolis, spent nearly $1.5 billion to buy a second portfolio segment from Macklowe and Fortress, the Credit Lyonnais Building at 1301 Avenue of the Americas. San Francisco-based Shorenstein Properties paid $990 million, according to RCA, to pick up a third Macklowe segment, Park Avenue Tower on East 55th Street as well as 850 Third Avenue.

Apartments ignite interest

Arguably, office and retail properties represented the weakest markets among the five major property types that also include apartments, hotels and industrial real estate. While the second-largest property sale raised needed cash for the seller, it also demonstrated the strength of the apartment sector.

DRA Advisors LLC, a New York-based investment firm, and Steven D. Bell & Co., a real estate investment and management company based in Greensboro, N.C., paid more than $1.7 billion to buy 25,700 apartments from Denver-based UDR, a multifamily real estate investment trust (REIT).

UDR sold 86 apartment communities for $1.5 billion in cash and a $200 million note. According to UDR, the apartment units posted an average rental income of $744 per month, and average occupancy of 94.4%. UDR said it planned to use at least 40% of the proceeds to pay down its debt, and roughly the same amount for acquisitions.

While its public statements indicated some financial pressure, UDR's strategy in selling the Southwestern portfolio, or 39% of its holdings, and keeping nearly 40,200 apartments on the Pacific Coast, near Washington, D.C., and in Florida, was to retain higher-paying units earning about $1,200 per month.

“The seller said [that] would allow them in one fell swoop not to butcher up their portfolio. So rather than sell a few properties in the East and a few properties in the West, they basically sold their entire Southwest portfolio,” says Martin Luskin, partner with the New York-based law firm Blank Rome, which helped DRA Advisors with its joint-venture purchase.

“They had expressed to me that multifamily continues to be a very safe investment, and they got some very attractive financing,” says Luskin. Fannie Mae, now under federal government conservatorship, provided the bulk of financing.

Structuring deals in 2008 was different from a few years ago when credit was plentiful, Luskin says. The key was assumable financing, getting the lender to agree that if the credit crunch continued, the buyers could assume the debt. With fewer transactions than in recent years, providing for a potential loan assumption avoids the need for new credit if the clients decide to sell, which appeals to prospective new buyers.

Companies also are taking creative approaches to raising capital. When Kushner Cos. of New York faced a July 1 deadline for refinancing a $335 million mezzanine loan, avoiding default and saving its $500 million in invested equity, it was unable to find credit until the Carlton Group stepped in.

Carlton says it facilitated a $630 million recapitalization of Kushner's retail condominium at 666 Fifth Avenue, arranging for a $325 million first mortgage, a $135 million mezzanine loan, and $170 million in equity.

“That money was used to pay off the [prior mezzanine loan], which was due right when this deal closed,” says Michael Campbell, a partner at the Carlton Group. The Kushner family had purchased the building a year earlier, he adds. “Their plan is to make deals with the existing tenants, who have low market rents, and buy them out. They can re-lease it sooner at higher market rents.”

The Carlyle Group and Crown Acquisitions announced on July 2 that they had bought a controlling interest in the retail portion from Kushner for $525 million. Kushner retains the office property.

Disappearing REITs

In 2007, REITs played a starring role in deal making with announced mergers and acquisitions of $68.7 billion. Just a year later, however, the picture was radically different. REITs were bailing out, and there were only two REIT mega buys through mid-December 2008.

Boston Properties' purchase of the $2.8 billion GM building notwithstanding, in the first 11 months the only other major REIT acquisition was Austin, Texas-based American Campus Communities' merger and purchase of 64 student housing properties from GMH Communities Trust, a REIT based in Newtown Square, Pa., along with a minority interest in eight properties held in two joint ventures. RCA valued the transaction at $1.2 billion.

In December, Chicago-based private equity firm Green Courte Partners LLC agreed to buy American Land Lease, a retirement community REIT, for $438 million. The struggling American Land Lease had announced that it would consider all offers as it tried to navigate the gloomy economy.

Although the Green Courte deal showed activity in the nearly moribund REIT sector, it fell far short of the Top 10 threshold. “It's pretty tiny relative to what we'd seen over the past couple of years,” says Keven Lindemann, director of real estate at Charlottesville, Va.-based SNL Financial.

REIT transactions all but dried up after commercial mortgage-backed securities lending came to a screeching halt late in 2007. That year, the average mega deal was $3.8 billion, Lindemann says. But by 2008, with capital markets traumatized by recession and fallout from the subprime crisis, it was difficult to get any transaction financed.

The value of equity REIT stocks dropped 51.5% from January through Dec. 12, 2008, according to the Dow Jones Equity All REIT index. Rising unemployment, slowing consumer spending and other trends buffeted most stocks, but the REIT stocks' plunge and company shrinkage was particularly visible, since REIT information is public.

Along with the size of deals, the cast of top players also changed last year. Blackstone, which displayed such a voracious appetite in 2007, buying not only Equity Office but also Hilton Hotels for $26.3 billion, is nowhere to be found on the Top 10 list of 2008.

And Blackstone is no longer as beefy as it was last year. The investment group reported a loss of $509.3 million in net income for the third quarter, compared with a positive flow of $299.2 million in the third quarter of 2007, and $99.9 million in the second quarter of 2008. Another star of 2007, Lehman Brothers, which partnered with Tishman Speyer Properties to buy apartment REIT Archstone-Smith Trust for $22.2 billion, filed for Chapter 11 bankruptcy protection on Sept. 15.

Collapsing deals

Some would-be mega deals never made it to the closing table. Toledo, Ohio-based Health Care REIT Inc. announced in September that it would acquire a 90% interest in a joint venture that owned 29 seniors housing properties managed by Sunrise Senior Living Inc. for $643.5 million. But less than two months later, the REIT terminated the agreement with an affiliate of Bahrain-based Arcapita, saying the transaction would not be in its stockholders' best interest.

According to New York-based research firm Real Estate Analytics (REAL) LLC, as many as half the major transactions scheduled to close in recent months may have collapsed before reaching the closing table, a historically high level.

In September, commercial real estate deals worth $20 billion were scheduled to close, but only $10 billion were completed. “Not every deal is broken — some may be delayed,” says Neal Elkin, REAL president. He believes that the rising cost of credit could result in more forced sales in 2009. While smaller deals below $7.5 million are showing a gain, those above that level are closing with an average loss of 1.3%, he says.

Sometimes credit falls through; other times buyers and sellers won't budge on price demands. “I've seen deals where buyers and sellers think they have a deal, and it falls apart,” says Samantha Wallack, partner at the law firm Blank Rome.

“On the multifamily end, it's less of a pricing issue that makes the deals blow up, but more of a liquidity issue,” Luskin says. In the retail arena, since Linens 'n Things filed for Chapter 11 bankruptcy protection in May and Circuit City Stores filed in November, investors expect others to follow. They are waiting until after the holidays to learn in the first quarter of 2009 whether other big retailers will fail before deciding whether to buy retail property and at what price, Luskin says.

Office investors, too, are wary, as word reaches the street that some rents may decline or that certain tenants may lose their shirts.

Tenants hunker down

The caution buyers showed in shying away from mega deals was also evident in the leasing market. As Manhattan's Class-A office vacancy rate climbed to 8.7%, its highest level since September 2005, tenants hesitated to make big changes, according to brokerage Colliers. “There certainly have been major transactions. The first one that jumps out is Viacom,” says Robert Sammons, director of research for Colliers.

Global entertainment company Viacom renewed its lease for 1.3 million sq. ft. at 1515 Broadway. In December Viacom announced it was laying off 7% of its workforce, or 850 people, and taking other cost-saving measures.

With tenants worried about the economy, the Manhattan office market didn't experience positive absorption in 2008, Sammons says. “I think people are feeling a little burned because they've heard that we've reached bottom. A month later something else happens and we fall back into that malaise.”

In response, tenants are asking landlords to negotiate lower rates or shorter terms. And landlords are willing to appease them to hold on to the tenants.

Bracing for the first quarter

There are encouraging signs. For December alone, Luskin's firm closed $1 billion in sales, although the law firm does not hold ownership in the properties and only represents the clients. But investors are on alert. Fresh retail bankruptcies could lower property prices, and the coming months could bring more forced sales.

Lenders are approaching troubled property owners sensibly, says Real Capital Analytics' Fasulo. “No lender wants these buildings back.” Deutsche Bank worked with Macklowe after he defaulted on the former Equity Office properties. “Deutsche Bank was very tough, but they were also very pragmatic in working out a plan,” he says.

Sammons of Colliers has kept statistics since the early 1990s, but this recession has him stymied. “It's the most difficult I've seen in terms of having to predict the next year or so. You feel like you may have a handle on it one day, and the next day another shoe drops.”

Meanwhile, credit problems are evident around the globe. In July, Spanish developer Martinsa-Fadesa, which invested in resorts, golf courses, malls and houses, filed for bankruptcy after failing to get a loan of €150 million.

The prevailing wisdom is that the U.S. may emerge from recession ahead of other nations, explains Fasulo of Real Capital Analytics. “I'm not sure I buy into that. We all need to come out of this mess together.”

Denise Kalette is senior associate editor.

Top 10 Commercial Real Estate Deals of 2008*

Price Properties Sold Sellers
$2.8 Billion 1.9 million sq. ft. office Macklowe Properties Fortress Investment Group
$1.7 Billion 26,000 apartment units United Dominion Realty Trust
$1.5 Billion 18.8 million sq. ft. industrial Vornado Realty Trust Morgan Stanley
$1.5 Billion 1.8 million sq. ft. office Macklowe, Fortress
$1.2 Billion 12,216 multifamily units GMH Communities Trust
$1.2 Billion 4,905 hotel rooms American Real Estate Partners LP
$1 Billion 4.7 million sq. ft. retail Macerich
$990 Million 1.2 million sq. ft. office Macklowe, Fortress
$900 Million 4,061 hotel rooms RLJ Development
$888 Million 1.2 million sq. ft. office Prudential RE, Sorgente SGR
*As of Dec. 8, 2008 Source: Real Capital Analytics