Lenders Choose Equity Over Taking the Cash

Try it before you buy it.

That’s how some real estate investors characterize a growing interest in convertible mortgages--loans that give lenders an option to take equity in a building instead of their money back.

In their most simple form, such convertible or participating mortgages allow the lender--usually a pension fund or insurance company--the choice to convert its note into ownership five to 10 years into the loan.

Convertibles offer the borrower a break of up to 3% on mortgage interest rates, not to mention loans of up to 90% on the value of a property. Lenders are touting convertibles so they can get a share of appreciation that they otherwise miss out on.

For foreign lenders such transactions are particularly attractive--for they rarely draw any public attention the way traditional sales do. While mainstream buyers get thrust into the limelight with the purchase of a trophy building, convertible investors manage to keep a low profile.

“Convertible loans have begun to dominate the top of the commercial real estate market,” said Marc Danzinger, vice president at the Westwood office of real estate brokerage Julien J. Studley Inc.

“If you buy an asset, you’re stuck with it,” he said. But, with convertible investments, he says, “the lender can always ask for its money back.”

Recent examples in Los Angeles include an estimated $300-million loan by LaSalle Partners to The Wilshire Courtyard, a joint venture of the J. H. Snyder Co. and CalFed Inc.

While all of the parties decline to comment on the late-summer deal, local brokers report that LaSalle has the option to convert its loan on the high-profile Miracle Mile office project to ownership sometime around 1995 or 1996.

In Beverly Hills, at 9595 Wilshire Blvd., TCW Realty Advisors Inc. completed an agreement last month to lend the owner $5.15 million at an interest rate 1.5 points under market. Within 10 years, the West Los Angeles-based pension fund manager can opt to take control of a majority of the 13-story office building. In the meantime, general manager Wallace Moir Inc. continues to enjoy all the tax benefits of ownership while writing off interest on its loan from TCW.

“It was the best deal we could make,” said Gary Griff, senior vice president of Beverly Hills-based Wallace Moir. “Convertibles are the best of both worlds. . . . We can ride out continued appreciation while at the same time pulling most of our money out.”

“The convertible loan allows us to invest in properties we could not otherwise acquire,” said Richard Pink, regional director of investments for TCW. And, he added, “it’s all custom tailored.”

Each deal, he said, is finalized with different convertible options--some which include a share of cash flow from rents, others that do not. Certain transactions provide TCW with an option to take over a complete project, others only give a 50% share.

“There has to be a great deal of trust between the lender and the borrower,” Pink said. Without a good working relationship between the two parties, a participating mortgage can work out to be a disaster for all concerned, he said.

“It’s like a marriage,” said Jack Cooper, managing director in San Francisco for Bank of America’s Investment Real Estate Group. “(With the wrong partner), you can have problems.”

As an asset manager for $800 million in investor funds, Cooper likes to keep his marriages short--three to five years at most. At the end of the loan term, the borrower does have the option to buy the property back, but usually B of A takes over or the property is sold to a new investor.

Why not just sell outright or take a conventional loan?

“There are some definite advantages to convertible financing,” said Jack Rodman, managing partner at the Century City office of accounting firm Kenneth Leventhal & Co.

The lender gets to “test the waters” before buying and ensure itself a share of future appreciation. For pension funds, which pay no income tax, deductions for depreciation and interest expense associated with ownership offer no benefit. By acting as lenders, these funds can let the owner take advantage of tax breaks that would otherwise go to waste in a purchase.

Convertible commercial loans--not to be confused with a different breed of convertible residential mortgages--also delay property reassessment that can cost an owner several million dollars a year in taxes. And, property owners who consent to a convertible get an immediate return on their equity and usually property management fees to boot.

New York has long been a popular center for convertible loans, especially when high interest rates left many borrowers with no other option. Retailing giant Sears also announced recently that it is exploring the possibility of taking a convertible loan on the Sears Tower in Chicago. Los Angeles seems to be following suit, with examples in Westwood, Encino, Newport Beach and Tustin.

Convertible financing is not without its skeptics, however.

“It’s been pushed by pension funds for several years,” said Alan Crittenden, publisher of the Novato-based Crittenden Report on real estate financing.

“The hard facts are that borrowers don’t want these loans,” Crittenden said. “The owner is better off selling in most cases.” By agreeing to such a deal owners give up much of the appreciation that makes real estate a good investment to begin with.

“Owners should accept a convertible loan as their very, very last resort,” Crittenden warned. Most of the time, he said, “it works against their own best interests.”

Rockefeller Deal’s Impact Uncertain

Cushman & Wakefield brokers are taking a “wait and see” approach to Mitsubishi Estate Co.’s purchase of a 51% share in their parent company, the Rockefeller Group of New York.

“It’s too early to tell if there will be any real operational changes,” said David M. McKenney, senior vice president at C&W; in downtown Los Angeles. “It could be very positive.”

Mitsubishi Estate of Japan announced last week that it invested $846 million for a majority interest in Rockefeller’s assets, including Rockefeller Center, Radio City Music Hall and an 80% interest in C&W.;

At worst, “it may be a non-event,” said McKinney. At best, the deal could add clout to what is already one of the nation’s biggest commercial brokerage companies. C&W; has seven Southern California offices with a staff of more than 300.

Tishman Realty Will Relocate Headquarters

Tishman Realty & Construction Co. Inc. will relocate its western headquarters in January to the recently completed Executive Tower in the Westside’s Garden District along Olympic Boulevard. Tishman served as construction manager for the 17-story office tower as well as the nearby Executive Life Center and Olympic Centre. Tishman Realty & Construction--not to be confused with Tishman West or Tishman Speyer--will relocate from 10960 Wilshire Blvd., an office building it developed and owned in the 1970s.

Metropolis Project Gets a New Partner

Metropolis--a 1.8 million-square-foot office/hotel/retail project planned for downtown Los Angeles--has a new development partner: Agenda California Inc. Out of the picture are Ronald S. Lushing and James R. Miller of Parkhill Partners, who intend to pursue other ventures.

Swiss-based Agenda and L.A. Center Inc. now plan to carry the Michael Graves-designed project to fruition, including three office towers and a hotel. Sited for the block bounded by 7th, 8th and Francisco streets and the Harbor Freeway, Metropolis is set for completion over a 10-year period. Last month, the city’s Community Redevelopment Agency certified the project’s final Environmental Impact Report.