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John Hancock Tower and Garage

On March 31, 2009, Jeff Gronning raised his paddle at the UCC foreclosure auction in City, and with a bid of $20.1 million became the new owner of the Tower and Garage in . Gronning, Managing Principal for Normandy Real Estate Partners (―Normandy’) represented a partnership (the ―Joint Venture‖) between Normandy and Five Mile Capital Partners (―Five Mile‖). The auction lasted a matter of minutes. Behind that bid, however, was ten months of intensive work by the Joint Venture, including the acquisition of a variety of mezzanine tranches (at substantial discounts) so that it would be very difficult and costly for anyone to outbid them.

The and Garage foreclosure sale stands as a high profile example of how the commercial real estate market has changed. Three years earlier this trophy property sold at a record breaking price of $1.35 billion. Now, its value had dropped almost in half. As much as any property in the , the multiple purchases and sales of the John Hancock Tower and Garage are a reflection of the unprecedented forces driving the commercial real estate market during the first decade of the 21st century.

With a total investment of $730.5 million, many industry insiders believed that Normandy and Five Mile made a great investment. Others argued they overpaid. Jeff Gronning and Jim Glasgow, a Partner at Five Mile, believed they had acquired a great asset. It would, however, need creativity, hard work and significant capital to make it a successful investment. Even in this moment of triumph, Gronning, Glasgow and their partners focused on three critical questions: What should they do first? How could they maximize the value of this investment? What could they do to protect themselves if the Boston office market continued to decline?

The Property ―When you look out the windows you can see forever,‖ said Jack Connors, chairman of Hill Holiday advertising agency, and a tenant on the 39th floor of the John Hancock Tower. ―If you want to have high expectations and grand plans, it’s a great place to be. You can’t think small in the Hancock Tower.‖i

Towering 790 feet into the sky, the 1.8 million square foot, 62-story, class A property is the tallest office building in , and Boston’s largest office tower. Located at 200 Clarendon Street, the John Hancock Tower sits in the heart of Boston’s Back Bay office district, across from Copley Plaza and (see Exhibit 1). As Beacon Capital CEO Alan Leventhal put it, ―When you look at Trinity Church reflected in the glass of the tower, you see juxtaposition of old and new that captures what Boston is all about. It’s the

This case was written by John D. Goldsmith Jr., Tuck ’09, and by John H. Vogel, Jr., Adjunct Professor, Tuck School of Business at Dartmouth. Some numbers have been disguised. It cannot be used or reproduced without the express written consent of one of the authors.

© 2009 Trustees of Dartmouth College. All rights reserved. For permission to reprint, contact the Tuck School of Business at 603-646-3176.

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heritage of Boston and the future of Boston.‖ii Tenants on the upper floors enjoy unobstructed, 360 degree views of downtown Boston, the , the Western suburbs and the Boston harbor. The eight-story Hancock Garage is located across the street at 100 Clarendon Street. It houses 28,000 square feet of retail space, and 2,013 parking spaces (see Exhibit 2).

The Back Bay submarket is located one mile west of Boston’s Financial District and is comprised of 80 blocks bounded by the Charles River to the north, Prudential Center and to the south, Arlington Street to the east, and Avenue to the west. The Back Bay submarket contains a mix of commercial and residential space. It is considered a premier office location with a multitude of transit options, quality space, and amenities such as restaurants, shopping, and theaters. With direct access to the , the Hancock Tower has been the home of many of Boston’s leading financial services, consulting, and advertising firms. (See interior office photos in Exhibit 2).

A Checkered Past Marking a new era in Boston’s history, the Prudential Center (now commonly known as the ―Pru‖) was dedicated in 1965. At 52 stories, it was the tallest building in the world outside of Manhattan, and nearly twice as tall as the existing corporate headquarters for the Boston based John Hancock Company (―John Hancock‖). Two years after the Pru’s completion, John Hancock announced plans to build its own tower – 40 feet taller than the Pru. John Hancock selected Henry Cobb from the world famous architectural firm I.M. Pei & Partners, who designed the 62-story glass tower to serve as its corporate headquarters. Criticism was swift and widespread, with the local planning board and the historical societies calling the plans ―an egotistical monument‖ and ―an outrage.‖ John Hancock threatened to move its operations to Chicago if they could not build this tower which forced the city to reluctantly grant approval.

Groundbreaking occurred in August 1968, and problems immediately plagued the project. After removing over 250,000 tons of earth, the unstable soils around the building began to sink. Trinity Church, the Copley Plaza Hotel, and nearby streets, sidewalks, and utility lines were affected. Rumors circulated that the tower was sinking and would have to be torn down. After paying damages of $11.6 million to nearby businesses, the project was allowed to continue. Then, starting in 1972, bouts of high winds caused the 500 pound, 5 by 12 foot windows to pop out, crashing to the sidewalks below. For the next four years, wooden canopies covered adjacent sidewalks, police closed off nearby streets when high winds were predicted, and the city hired spotters with binoculars at Copley Square to monitor the windows. At its worst, plywood covered 33 floors of the exterior, and by 1976 all 10,334 panes of glass were replaced and a state of the art monitoring system was installed at a cost of $8 million. Amazingly, nobody got injured from the falling glass.

The next problem was that the top floors of the tower swayed to an unsettling degree, and under extreme and rare wind conditions, engineers worried the building might topple over. The solution included the installation of a tuned mass damper which consisted of two 300 ton weights positioned at each side of top floor. Hancock also braced the inner core of the building with 1,500 tons of steel. Building costs soared from $75 to $175 million, and the

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opening of the John Hancock Tower was delayed five years. The John Hancock Tower was finally dedicated on September 29, 1976. With such an embarrassing history, it is hard to imagine this property slowly evolving into a masterpiece, but in 1994 a Boston Globe Poll of architects and historians rated it Boston’s third best work of architecture, behind only Trinity Church and the Boston Public Library. As Thomas Farragher from wrote in 2006, ―Today, the city that checks its reflection in the tower’s signature skin has largely dismissed its ugly past as an amusing piece of local lore, like the Bambino’s curse … Few can summon an image of Boston without it—or would want to.‖iii

Beacon Capital Although Beacon Capital Partners was incorporated in 1998, its roots in the real estate industry extend back more than sixty years. The first of the ―Beacon Companies‖ was founded by Norman Leventhal in 1946. Leventhal and his brother started as commercial construction contractors and later became full-scale developers. During the 1980s, the Beacon Companies developed and/or constructed over $1 billion worth of commercial properties, including Rowes Wharf, , Wellesley Office Park and the Meridian Hotel. In May 1994, the Leventhal family put their interests in 15 properties, constituting most of their real estate holdings, into a single company called Beacon Properties Company and went public with Alan Leventhal as President and CEO. During the next three years, Beacon Properties Company grew rapidly through acquisitions, development and redevelopment. By 1997, it was one of the largest office REITs in the United States.

In December 1997, Equity Office Properties purchased the Beacon Properties Company for $4 billion, which was then the largest merger of two publicly traded REITs. The acquisition price represented approximately a 60% premium over the Net Asset Value of the properties owned by the Beacon REIT. It also meant that investors who purchased stock at the IPO in May 1994 and sold it in December 1997 received a 245% total return or an annual compounded return of 42%.

After the sale of the Beacon REIT, Alan Leventhal started a private equity company called Beacon Capital Partners and raised $470 million in its first fund. Beacon Capital Partners focuses on acquiring office properties in ―knowledge based‖ markets, such as Boston, New York, DC, and San Francisco.

Beacon’s Purchase of the John Hancock Tower After suffering over $200 million in investment losses in 2002, Services decided to sell the John Hancock Tower and Garage, along with two other Boston office buildings: 197 Clarendon Street and 200 Berkeley Street. Potential buyers for these trophy assets included Beacon Capital, Equity Office Properties, and Tishman Speyer Properties. Real estate experts predicted that these properties would sell for about $850 million. At the time, capitalization rates for office properties in the Boston Central Business District (CBD) were trading in the 8.5-9% range (see Exhibit 3).

In negotiating a price for these properties, Beacon hoped that since John Hancock would remain as a tenant in the building, it would be concerned about more than just the price. So in addition to dollars, Beacon Capital promised to keep the Hancock name on this signature

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building and hire people from Hancock’s staff to manage the building. Beacon Capital also got John Hancock to agree that it would extend its lease on its existing space for an additional 10 years, and lease an additional 120,000 square feet of space at $44 per square foot, with annual cost of living increases.

Beacon Capital then submitted the winning bid for all four properties for a record price of $925 million.1 The sale of the John Hancock complex was the largest single real estate transaction in the history of the Boston market, easily surpassing Boston Properties’ $519 million purchase of the Prudential Building in 1998.

The Boston Office Market in 2003 and Beacon’s Investment Thesis During the tech boom, office building rents in the premier, Boston buildings peaked at $80 per square foot. By 2003, average rates were down by almost 50% and heading lower (see Exhibit 3.) Over this same time period, unemployment doubled from 2.4% to 5.1%, and in the Back Bay office submarket, vacancy grew from 2.6% to over 18%. In this economic climate, finding tenants willing to pay even $40 per square foot in rent was challenging. As one local real estate consultant proclaimed, ―In Boston, investors are missing the real estate fundamentals. The rents do not justify the prices they are paying. Firms already have too much space, and without demand, rents will continue to fall.‖iv

In acquiring the John Hancock Tower and Garage, Beacon was concerned about the Boston office market, but believed they could deal with that risk. As Leventhal explained, ―At the end of the day, the reason we bought the John Hancock complex is this is a great investment.‖v Two key factors Leventhal cited were: The average per square foot cost of the tower was $315, which he believed was about 30 percent under what it would cost to replace the building. There were potential opportunities to increase cash flow by adding lucrative retail space to the ―Old‖ Hancock building and in upgrading the garage.

While Beacon was confident of their investment in these buildings, others were skeptical of the record setting price. Critics claimed Beacon had overpaid.

Broadway Partners The son of a Queens NY cab driver, Scott Lawlor founded Broadway Partners Fund Manager LLC (―Broadway‖) in 2000. Broadway’s first acquisition was a $4.8 million former school building in Hartsdale, NY. Since then Broadway has purchased over $15 billion of commercial real estate. With annual returns averaging 35%, Broadway was able to raise substantial capital from investors. The firm quickly caught the attention of its competitors, with their aggressive use of debt and willingness to close deals quickly. In describing Broadway’s strategy, Lawlor explained, ―We have a very strict discipline we try to bring to bear about sales. Once a building’s income has increased, the company’s job is done.‖vi

1 The case writers estimated that of this $925 million purchase price, approximately $640 million was for the John Hancock Tower and Garage, and the other $285 million was for the other two office buildings. To finance the John Hancock Tower and Garage, Beacon invested about $205 million of equity, and obtained a $435 million mortgage.

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Beacon Liquidates By 2006, Beacon had completed a number of capital upgrades to the properties in its Fund II portfolio. For the John Hancock Tower and Garage, the biggest upgrade was a $10 million renovation of the Garage. The Garage upgrade included installing state of the art access and revenue control systems, improved lighting, landscaping and new directional signage. Beacon reconfigured the parking area and created 115 additional parking spaces. While Beacon believed there might be additional upside from holding the property, given the appreciation that had already taken place, Beacon decided to sell the property and return capital to its investors.

Fund II consisted of ten well positioned, Class A office properties in Boston, Washington D.C. and Los Angeles. Beacon hired Eastdil Secured and Morgan Stanley to market its Fund II properties. Rather than purchase individual properties, Broadway agreed to purchase the whole portfolio.2 For the ten building, 6.9 million square foot portfolio, Broadway paid $3.4 billion. Simultaneous with closing, Broadway sold four properties and kept six including the John Hancock Tower and Garage.

To finance this acquisition, Broadway secured individual, non recourse first mortgages on each of the six properties. In the case of the John Hancock Tower and Garage, the first mortgage was a ten year, $640.5 million, interest only, assumable mortgage at a 5.6% fixed rate. The John Hancock Tower and Garage was also financed with a $472 million mezzanine loan3 and $237.5 million of equity for a total of $1.35 billion.

Boston Market: 2006 Long viewed as the poor man’s New York because of its less expensive properties, Boston sizzled as a hot market for investors in 2006. According to one local real estate professional, ―There is no end to the appetite for investment sales in the Boston area. There is more money out there than product.‖vii With rising construction costs, limited new supply and lower per square foot sales prices than in other major U.S. markets, many investors viewed Boston as great place to invest. Furthermore, 2006 saw strong leasing demand, with nearly one million square feet of net absorption of office space

As can be seen in Exhibit 3, vacancy in the Boston office market peaked at 14% in 2004 and then began to decline. By mid 2006, the market favored the landlords. Tenants lost much of their negotiating leverage. Strong demand for large leases (over a hundred thousand square feet) took a great deal of space off of an already tightening market, causing rents to increase. However, when compared to other major cities, Boston still seemed inexpensive. Class A

2 Fund II was structured as a private REIT. The safe harbor rules governing REITs made it advantageous to sell the company and all its assets rather than individual properties. 3 The $472 million mezzanine loan was part of a $723 million mezzanine loan that Broadway used to finance all six properties. The term of this mezzanine loan was one year with two, six month extensions. It carried an interest rate of Libor plus 394 basis points. Unlike the first loans which were secured by individual properties, the mezzanine loan was cross defaulted and cross collateralized. Cross collateralization means cash flows from one property can be used to offset shortfalls from another. Cross defaulting means that if one property defaults, the lender can foreclose on all the properties. For calculation purposes please assume that with the first mortgage at 5.6% and the mezzanine loan averaged about 9.2%. The weighted average rate on Broadway’s $1.1 billion of debt was 7.13%.

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office leases were being signed in NYC for $135 per square foot, Washington DC for $87 per square foot, and LA for $64 per square foot. One Boston landlord commented, ―I think we're in for some very interesting times, and I plan on enjoying it.‖viii

Broadway Takes Over Just prior to Broadway’s acquisition, Beacon leased some space at $63 per square foot, a new record for the Hancock Tower. When Broadway acquired the building, the Hancock Tower was nearly 100% occupied. From Broadway’s perspective, one of the attractive aspects of this investment was that many of the tenants at the Hancock Tower had below market rate leases which were due to expire in the next few years (see Exhibit 5). Broadway saw this as an opportunity to substantially increase the building’s Net Operating Income (NOI).

As an example of this strategy, Broadway quoted Hill Holiday a renewal rate of $80 per square foot, effectively doubling their existing rents. Hill Holiday CEO, Michael Sheehan commented, ―It was clear they paid a certain amount for the building and had to charge high rents. That just wasn’t our problem.‖ix Ultimately, Hill Holiday decided to move out, while others chose to say and accept the higher rents. In 2007 and 2008, Broadway signed about 180,000 square feet of leases at an average rate of $62, with a few larger leases at over $70 per square foot. On the other hand, they lost some large, prestigious tenants such as Marsh McLennan and Deloitte & Touche.

In the summer of 2007, Broadway started a two pronged strategy to either sell or refinance the property. There was considerable investor interest in the Hancock Tower and Garage. However, tremors in the credit and equity markets caused at least one potential buyer to withdraw its offer. In order to recapitalize the building and deal with the impending maturity on the mezzanine debt, Broadway hired Cushman and Wakefield. However, the same deterioration in the credit markets that caused the potential buyer to walk away also prevented Broadway from refinancing or replacing the mezzanine debt.

Normandy Real Estate Partners Founded in 2002, Normandy Real Estate Partners is headed by Finn Wentworth, David Welsh and Jeff Gronning. Collectively, these three principals have 51 years of experience in acquiring, financing, managing and selling real estate assets. Wentworth and Welch specialize in acquiring and managing institutional quality properties. Gronning has extensive capital markets expertise from his years as senior manager and CFO of Morgan Stanley’s Real Estate Funds. Normandy quickly established itself as an integrated owner and operator focusing on New England and the Mid-Atlantic regions. By March 2009, Normandy had acquired more than 15 million square feet of commercial office space, 2,500 apartment units and 1,100 hotel rooms. Normandy raised institutional capital in 2005 and 2007, enabling them to acquire debt and equity positions in over $4 billion of real estate.

Five Mile Capital Partners After twelve years as co-CEOs of Greenwich Capital and its successor Greenwich NatWest, Chip Kruger (Tuck 1977) and Gary Holloway founded Five Mile Capital Partners, along

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with Steven Baum from Paine Webber4 and Thomas Kendall, the former CIO of Greenwich Capital. Since 2003, Five Mile has invested over $4 billion. The firm describes itself as ―an alternative investment and asset management company that specializes in investment opportunities primarily in commercial and residential real estate and also invests in debt products and asset-based lending.‖

Shortly after its founding, James ―Jim‖ Glasgow joined Five Mile as part of the senior leadership team and head of commercial real estate. Glasgow had been a senior vice president at UBS Warburg and earlier in his career had worked at Travelers Insurance Company. At Travelers in the early 1990s, Glasgow was involved in $6-7 billion dollars of workouts across the United States including debt restructures, foreclosures, bankruptcy litigations and asset sales. As the commercial real estate markets began its latest collapse Glasgow remarked ―it felt very familiar.‖

A Market Dislocation In early 2007, the commercial, real estate market seemed healthy and strong. Defaults on existing loans were at historical lows, and demand for space was strong in most major markets. A combination of low capitalization rates and plentiful, inexpensive financing pushed sales prices to record levels. In the summer of 2007, however, financial firms reported major losses from their subprime residential mortgages, which raised concerns among commercial lenders and institutional investors. In particular, pension funds, insurance companies and other major buyers worried about their real estate exposure and stopped buying commercial mortgage backed securities (CMBS), which was the main source of long term debt for commercial properties.

In 2007, CMBS issuance totaled $230 billion (or $630 million per day). CMBS financing represented approximately 50% of the debt originated in 2007 and close to 90% of the new, long term debt. In 2008, CMBS issuance dropped to $12 billion. Without a reliable source of long term debt the commercial real estate markets became paralyzed, and sales of larger commercial properties dropped by 69%, year over year.

Opportunistic real estate funds, like Broadway, with a strategy involving a great deal of short term debt, were in a bind. There were no buyers for their properties and no lenders willing to refinance their loans. Their best hope lay in trying to increase the cash flow from their properties, but along with the credit markets, the overall economy slowed down causing businesses to contract. In 2008, leasing in Boston and in most major markets slowed significantly (see Exhibit 3).

In this depressed market environment, Normandy and Five Mile utilized their extensive networks of relationships to try to locate distressed, real estate opportunities. Rather than purchase properties, their strategy was to buy loans at a discount from lenders. In particular, Normandy and Five Mile each started looking for debt on trophy office towers in downtown locations where they could make an attractive return if the loan was repaid (because they

4 Steve Baum had a unique background. Before going to Wall Street, he earned a PhD in applied Mathematics from Cornell. Baum began his Wall Street career at Salomon Brothers in 1979 where he worked for Lewis Ranieri who is considered the ―father of securitization‖, the process by which companies turn mortgage loans into bonds.

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bought it at a discount) or enforce their rights and remedies as a lender and take ownership of the property if the mortgage defaulted.

Boston Office Market: 2008 & Early 2009 In 2008 and 2009, Boston’s unemployment jumped from 4.4% to 6.6%. Over a million square feet of office space came back onto the market as companies moved out, sublet their space or went bankrupt. The Financial and Back Bay Submarkets were hit particularly hard. Vacancy rates soared from 6.1% to 10.3% and rents for Class A properties fell from $65.54 to $54.20 per square foot (see Exhibit 3).

Normandy and Five Mile’s Opportunistic Approach Both Normandy and Five Mile looked for opportunities where the capital structure, not the underlying properties, would cause the default. Separately and eventually together as a Joint Venture, Normandy and Five Mile began to focus on the Broadway Fund II portfolio. In particular they liked the fact that:

1) The $640.5 million first mortgage on the John Hancock Tower and Garage was assumable, and not cross defaulted with the mezzanine loan. Secured only by this individual property, the loan had over 8 years left until maturity, and had an attractive 5.6%, interest only, fixed rate. 2) There was a high probability that in the near future the mezzanine loan would default. Furthermore, because this mezzanine debt was segmented into eight tranches with at least seven different investors, it would be hard to get consensus to modify or restructure the loan. 3) Most of the investors in the mezzanine debt were yield, driven financial investors. They were neither interested nor capable of managing the underlying property. 4) With only a few months left until maturity, and almost no lenders willing to make new, real estate loans, there was a high probability that Broadway would not be able to service or restructure this mezzanine debt. Therefore, if properly executed, the joint venture thought it could successfully implement its ―loan to own‖ strategy for the underlying collateral.

Normandy and Five Mile now focused its underwriting and due diligence on three questions: What was the underlying real estate worth? Which slice of the complicated debt structure would put them in the best position to influence the outcome of the foreclosure proceedings? What are the risks inherent in the existing loan documents, inter-creditor agreements and mezzanine participation agreements?

The joint venture hired two prominent law firms to help with the myriad of legal issues including bankruptcy, the Uniform Commercial Code (UCC) foreclosure process and potential litigation from Broadway and other parties. The biggest challenge for the partners and staff at Normandy and Five Mile was determining the value of the underlying real estate assets. Their goal was to acquire the tranche of the mezzanine loan that intersected with their assessment of the property value, hoping to own the Controlling Holder position, or ―fulcrum security,‖ in the case of a default.

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After valuing the John Hancock Tower and Garage5, the joint venture identified the A-2 tranche of the mezzanine loan as their target position in the capital structure. In June 2008, the joint venture purchased the A-2 tranche at a discount to its par value. The original face value of the loan was $50 million,6 but the partnership obtained almost 90% financing from the seller. At this point, the capital structure of the John Hancock Tower and Garage included the $640.5 million senior loan, $472 million of allocated, mezzanine debt and Broadway equity. As shown in Table A, the most secure slices of the capital structure were the closest to the bottom. In the event of a sale or foreclosure, payments would be distributed 7 sequentially beginning with the $640.5 million first mortgage .

5 The Joint Venture actually had to value all the assets since the mezzanine debt was cross collateralized. However, to avoid confusion, we will generally ignore the other four properties, which greatly complicated the Joint Venture’s underwriting and analysis. 6 The actual A-2 piece was $75 million, but to simplify the transaction the case writers have apportioned $50 million to the John Hancock Tower and Garage. 7 Table A reflects the original capital stack when Broadway purchased the building except that Normandy and Five Mile did not own the A-2 tranche.

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Table A: ($000): Broadway's Capital Structure For the John Hancock Tower

100%

$237,500 Broadway Equity 90%

$30,000 Mezz Tranche E $30,000 Mezz Tranche D 80% $31,000 Mezz Tranche C $105,000 Mezz Tranche B 70% $50,000 Mezz Tranche A - 3 $50,000 Mezz Tranche A - 2: Normandy/ Five Mile

Tranche 60% $94,000 Mezz Tranche A - 1

Mezz Tranche A - 1 $82,000 50%

40%

30% Senior Loan: CMBS Deal $640,500 GCCFC 2007 - GG9 20%

10%

0% $1,350,000 Acquisition Cost

In January 2009, the mezzanine loan came due. As set forth in the original participation agreement which governed the mezzanine loan, to determine who would be the ―controlling holder,‖ the servicer hired Cushman & Wakefield to perform an appraisal of the property. Cushman & Wakefield valued the Hancock Tower and Garage at $828 million, a decline of 36% from Broadway’s acquisition price. This updated appraisal coupled with a specific ―controlling interest‖ calculation provision in the participation agreement meant that the lower tranches (A-3 though E) were ―out of the money‖. Investors in these lower tranches no longer had any significant influence over the property’s outcome. As the last entity still in the money, the Joint Venture became the Controlling Holder and named Green Loan Services, a subsidiary of SL Green, to act as the special servicer for the mezzanine lenders.

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Among other things, the special servicer handles issues related to the default. The special servicer takes direction from the Controlling Holder and obtains consensus, where necessary, from the other participants.

In February 2009, the joint venture negotiated the purchase of additional tranches of the mezzanine debt.8 SL Green issued a Public Notice as a preliminary step in the process of auctioning and selling the property. The Joint Venture obtained ―Qualified Transferee‖ designation from the rating agencies so that it could assume (and not have to pay off) the $640.5 million CMBS mortgage if it were the successful bidder at the foreclosure auction.

In March a public UCC foreclosure auction was held in New York for the John Hancock Tower and Garage9. Any proceeds above the senior mortgage would be distributed to the mezzanine tranches. By the time of the auction, the Joint Venture owned all the senior portions of the mezzanine debt (A-1 through A-3) and partial interests in the B and D Tranches. It could bid up to the face amount of their mezzanine tranches before it cost Normandy and Five Mile any additional capital. Thus it was difficult for any other bidders to compete. As required, the special servicer bid $20 million over the senior loan, with the Joint Venture quickly responding with a bid of $20.1 million,10 plus assumption of the senior loan of $640.5 million. As the new owner of the John Hancock Tower and Garage, their total investment in the property was approximately $730.5 million.

Acquisition (mm)

First Mortgage $640.5

Mezzanine Loans, Legal and Closing Costs11 $90

Total $730.5

For Gronning, Glasgow and the Joint Venture, the acquisition of the John Hancock Tower and Garage represented the culmination of ten months of hard work. The partnership between Normandy and Five Mile proved to be a good blend of real estate expertise and distressed debt workout expertise. Jim Glasgow noted that it was ―one of the largest UCC foreclosures in history‖ (see Exhibit 8.) More hard work lay ahead. As Gronning commented, ―We’re not just going to come in here and blow smoke.‖x Their first job would

8 Normally, tranches that are out of the money (in this case those tranches subordinate to the A-2 tranche) have very little value and can be purchased for a nominal amount, which is what Normandy and Five Mile did. Tranches senior to A-2, normally could not be purchased at a discount, since they would have to be paid off in full upon sale. However, in this case, Normandy and Five Mile negotiated a discount because the credit crisis put pressure on the owners of these senior tranches to liquidate whatever non liquid investments they could. 9 At the auction, Normandy and Five Mile also purchased 10 Universal City Plaza in Los Angeles from the Broadway portfolio. The other four Broadway office properties were sold prior to the auction. 10 This $20.1 million is included in the $85 million dollar mezzanine loan acquisition cost, as these funds are essentially purchasing the mezzanine loan, which Normandy and Five Mile Capital already own. 11 The $90 million of Mezzanine loans and closing costs is an estimate by the case writers. It includes purchases by Normandy and Five Mile of all their mezzanine tranches.

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be restoring the buildings reputation with the existing tenants. According to Dan Revers, the CEO of ArcLight Capital and tenant on the 55th floor, when Broadway encountered financial difficulties the quality of the staffing and maintenance went downhill (see Exhibit 7). The second job would be to bring in new tenants to fill the 16% of the building that was currently vacant (see Exhibit 6).

The Joint Venture faces significant challenges. What can they do to improve the image and operations of the building? Were there capital improvements that would make the building easier to lease and/ or improve the buildings net operating income? With such a high profile property, both Normandy and Five Mile’s reputations would be linked to what they are able to achieve with the John Hancock Tower and Garage.

Study Questions:

1) In 2003, what did Beacon Capital like about the John Hancock Tower and Garage? What were the biggest risks? How did they mitigate those risks? 2) How would the be different from a physical standpoint if it had originally been built as a multi-tenant building rather than a headquarters building? 3) For Beacon Capital, the purchase and sale was a homerun. What part of this success was the result of their skill and what part was luck? 4) When Broadway bought the property in 2006, what were they betting on? What mistakes did they make? 5) What skills enabled Normandy and Five Mile to get control of this property? What are some of the risks associated with its ―loan to own‖ strategy? 6) Did Normandy and Five Mile get a good deal? What should they do first to hold onto their existing tenants and restore the building’s reputation?

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Exhibit 1: Location of the John Hancock Tower and Garage

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Exhibit 2: John Hancock Tower Property Photos

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Exhibit 2 (cont’d): Property Photos (Sample Floor Plate)

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Exhibit 2 (cont’d): Property Photos

Vacant Space in the John Hancock Tower

Finished Office Space: A number of tenants have telescopes in their waiting area.

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Exhibit 2 (cont’d): Property Photos

Cafeteria in the basement of the John Hancock Tower

View Along St. James Street: Hancock on the left, Trinity Church on the Right and the in the background.

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Exhibit 3: Boston Office Market

Class A Office Capitalization Rates: 2002 - 2009 10.00%

9.00%

8.00%

7.00%

6.00%

5.00%

Boston quarterly avg US quarterly avg

Back Bay Class A Office Market Statistics 1998 - 2009 Q1

# of Under Overall YTD Leasing YTD Net Avg. Rental Year Total SF1 Buildings Construction Vacancy Activity Absorption Rate2 1998 6,750,693 15 553,255 1.1% 287,843 150,931 $35.22 1999 6,750,693 15 1,457,244 0.4% 1,469,401 16,550 $47.69 2000 6,991,634 16 1,770,244 2.6% 854,311 80,785 $62.23 2001 8,509,822 18 369,172 11.9% 866,345 952,100 $55.39 2002 8,570,357 19 360,202 11.7% 461,230 (207,429) $42.10 2003 9,898,888 22 0 11.1% 507,272 105,761 $37.51 2004 8,543,741 19 0 18.4% 548,742 (103,549) $36.62 2005 8,466,427 19 0 11.0% 602,144 450,835 $37.09 2006 8,466,427 19 0 10.9% 852,800 99,624 $39.73 2007 9,117,427 20 0 6.6% 1,177,925 332,740 $56.08 2008 9,117,427 20 0 7.0% 234,723 (228,669) $60.21 Q1 2009 9,117,427 20 0 11.8% 28,686 (602,108) $52.80 Source: Cushman & Wakefield 1 Changes in inventory reflect additions / deletions as well as new construction. Owner-occupied buildings are excluded. 2 Weighted Average rental rate on space.

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Exhibit 3: Boston Office Market (Continued)

Boston CBD Class A Historical Data Average Vacancy Rates vs Average Asking Rental Rates

16.00% $70.00 $65.54

14.00% $59.98 13.78% $59.39 $56.96 $60.00 12.03% 13.43% 12.70% $54.20 12.00% $49.21 11.58% $48.50 $50.00 10.30% $42.49 10.00% $40.69 $41.46 $38.57 $37.42 9.28% $40.00 8.13%$35.98 8.23% 8.00% $32.37 $29.45 $27.34 $30.00 6.00% 6.53% 5.23% 6.10% $20.00 3.78% 4.00%

3.78% 2.88% $10.00 2.00% 1.63%

0.00% $0.00 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

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Exhibit 4 – Financial Projections in 2003, at time of Beacon Capital Purchase

John Hancock Building & Garage Projected Proforma Statement for 2003 Gross Rent: (000's) Tower $ 70,700 Garage $ 10,570

Reimbursement Revenues Operating Escalations $ 3,265 RE Tax Escalations $ 987 Utility Escalations $ 3,035 Overtime Escalations $ 518 Miscellaneous Revenue Antenna $ 596 Miscellaneous $ 684 Total Gross Rent $ 90,355 Vacancy 8.90% $ (8,042) Effective Gross Revenue $ 82,313 Operating Expense $ 37,276 Net Operating Income $ 45,037 Debt Service ($435 MM) 4.5% ($19,575) Net Cash Flow $ 25,462 Cash On Cash Return 12.4%

Lease Expiration Schedule: 2003 Cumulative of Year Ending December 31, Expiring SF % of Total Total

2003 2,118 0.1% 0.1% 2004 0 0.0% 0.1% 2005 0 0.0% 0.1% 2006 170,444 9.7% 9.9% 2007 256,442 14.6% 24.5% 2008 489,044 27.9% 52.4% 2009 83,805 4.8% 57.2% 2010 60,016 3.4% 60.6%

2011 88,687 5.1% 65.7% 2012 95,620 5.5% 71.2% 2013 & Thereafter 469,575 26.8% 98.0% Vacant 35,359 2.0% 100.0% Total 1,751,110 100.0%

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Exhibit 5: Financial Projections in 2006, at time of Broadway Partners Purchase

John Hancock Building & Garage Projected Proforma Statement for 2006 Gross Rent: (000's) Tower $ 73,275 Garage $ 11,630 Reimbursement Revenues Operating Escalations $ 3,442 RE Tax Escalations $ 1,107 Utility Escalations $ 3,123

Overtime Escalations $ 537 Miscellaneous Revenue Antenna $ 614 Miscellaneous $ 702 Total Gross Rent $ 94,430

Vacancy 2% $ (1,889) Effective Gross Revenue $ 92,541 Operating Expense $ 41,314 Net Operating Income $ 51,227

Tenant Roster & Lease Expiration: 2006 % of Total Underwritten Base Rent / Next Lease Tenant Name Square Feet SF Base Rent % of Base Rent SF Expiration John Hancock 415,361 23.7% $ 21,586,306 29.6% $ 51.97 3/1/2008 IBT Company 387,234 22.1% $ 12,522,004 17.2% $ 32.34 12/1/2014 Ernst & Young 146,496 8.4% $ 6,559,701 9.0% $ 44.78 12/1/2016 Hill Holiday 133,005 7.6% $ 5,586,210 7.7% $ 42.00 12/1/2008 Mercer Mgmt Consulting 99,911 5.7% $ 3,537,067 4.9% $ 35.40 4/30/2008 Total Largest Tenants 1,182,007 67.5% $ 49,791,288 68.3% $ 42.12 Remaining Tenants 562,170 32.1% $ 23,136,283 31.7% $ 41.16 Vacant Space 6,933 0.4% $ - 0.0% $ - Total All Tenants 1,751,110 100.0% $ 72,927,571 100.0% $ 41.65

Lease Expiration Schedule: 2006 Cumulative of % of Base Underwritten Year Ending December 31, Expiring NRSF % of Total Total Base rent Rent Base Rent 2007 2,658 0.2% 0.2% $ 53,564 0.1% $ 20.15 2008 367,120 21.0% 21.1% $ 15,727,922 21.6% $ 42.84 2009 158,687 9.1% 30.2% $ 5,339,684 7.3% $ 33.65 2010 46,446 2.7% 32.8% $ 2,911,192 4.0% $ 62.68 2011 21,391 1.2% 34.1% $ 1,468,199 2.0% $ 68.64 2012 39,405 2.3% 36.3% $ 2,439,623 3.3% $ 61.91 2013 52,346 3.0% 39.3% $ 2,344,568 3.2% $ 44.79 2014 432,781 24.7% 64.0% $ 14,186,911 19.5% $ 32.78 2015 395,736 22.6% 86.6% $ 20,670,839 28.3% $ 52.23 2016 209,979 12.0% 98.6% $ 7,194,531 9.9% $ 34.26 2017 & Thereafter 17,628 1.0% 99.6% $ 590,538 0.8% $ 33.50 Vacant 6,933 0.4% 100.0% $ - 0.0% $ - Total 1,751,110 100.0% $ 72,927,571 100.0% $ 41.65

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Exhibit 6: Financial Projection, at time of Normandy/ Five Mile Capital Purchase John Hancock Building & Garage Projected Proforma Statement for 2009 Gross Rent: (000's) Base Office Rent $ 71,150 Retail & Storage $ 1,428 Antenna & Other $ 1,022 Garage $ 12,120

Reimbursement Revenues Operating Escalations $ 3,010 RE Tax Escalations $ 3,511

Utility Escalations $ 3,218 Overtime Escalations $ 662 Total Gross Rent $ 96,121

Vacancy - Office Only 16% $ (11,384) Effective Gross Revenue $ 84,737

Property Management Fees $ 830 Management Payroll $ 1,866 Utilities $ 10,324 Cleaning $ 2,721 Security $ 1,975 Repairs & Maintanence $ 2,244 Insurance $ 1,755 Real Estate Tax $ 19,050 Total Operating Expense $ 40,765

Net Operating Income $ 43,972

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Exhibit 7: A Tenant’s Perspective

Dan Revers, founder and CEO of ArcLight Capital, has been a tenant in the John Hancock Tower since 2000. His company started by occupying 5,000 square feet on the fifty-fifth floor. It then expanded twice when space on that floor became available. They now occupy the full floor.

In Revers’ view, this building has some wonderful features, but is far from perfect. ―The panoramic views are unmatched in any office building in Boston,‖ he observed. ―And the convenience of having a parking garage with a ramp that takes you directly onto the Massachusetts Turnpike saves a great deal of time and hassle.‖ Revers felt the building was particularly appealing for executives living in the affluent suburbs, west of Boston.

On the other hand, unlike most modern office buildings, there are few retail stores in the building or even a Starbucks. Revers noted that there is a large cafeteria in the basement that harkens back to the time when it was the headquarters building for John Hancock. ―When we order lunch for a meeting in our office,‖ Revers pointed out, ―we never use the cafeteria or the food service in the building.‖ The HVAC (heating, ventilating and air conditioning) systems are antiquated. Revers estimates that 10-15% of the usable office space is taken up by columns and the floor mounted HVAC units that run along the exterior walls (see photograph of the vacant office in Exhibit 2). ―This two loop system‖, Revers explained, ―has such long runs that there are two completely different climates on my floor.‖

Under John Hancock’s ownership, Revers thought the building was kept clean and ran smoothly, though he wondered how efficiently it was managed since there always seemed to be ―tons of people‖ hanging around wearing John Hancock uniforms. Beacon managed the building in an efficient, ―world class‖ manner. Under Broadway, especially as they encountered financial problems, cleanliness and the quality of the staffing ―went down‖. It is too early to tell what the property management will be like under Normandy, but Revers thought they ―are saying all the right things about what they intend to do‖ and ―adding flowers in the lobby has been a nice touch.‖ Like all the recent owners, Normandy will face the challenges of working with multiple tenants in a building that was originally designed as a single tenant building.

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Exhibit 8: Advice in Acquiring Properties Through Bankruptcy

Jim G. Glasgow, a Partner at Five Mile has vast experience dealing with bankruptcy issues as a lender and purchaser of debt-instruments. In the 1990s, he was involved with $6-7 billion worth of distressed properties many of which went into bankruptcy. Currently, he leads Five Mile’s efforts to purchase distressed debt, often with the intention of gaining an ownership stake as it did in the John Hancock Tower and Garage in Boston and the Times Square Building in Manhattan. Glasgow offered the following advice for dealing with distressed property that could potentially be acquired through bankruptcy, foreclosure or a deed in lieu of foreclosure.

1. Begin the analysis with the property itself. Is it good real estate? What are the current and projected cash flows? What is its real value? 2. Protect your downside. In the John Hancock acquisition, by purchasing the mezzanine debt at a discount, Five Mile was guaranteed a 25% return on its initial equity investment if someone else purchased the building. 3. Carefully analyze your rights and remedies as a debt holder. a. One of the critical documents is often the inter-creditor agreement, which governs the dealing between all the holders of debt. Does the inter-creditor agreement allow a change of control? Does it give you the right to foreclose? Does it allow you to assume the senior debt or do you have to pay it off? b. In this case, a second critical document was the participation agreement which governed the relationship between all the parties that owned pieces of the mezzanine debt. The Joint Venture went through contortions in structuring the auction to be sure they complied with the participation agreement and would not get sued by the other mezzanine lenders. 4. Will you get sued? In any bankruptcy people are losing money and therefore the chances of getting sued are higher. Before getting involved in an acquisition it is important to carefully consider who is getting hurt and the likelihood that you will end up with legal problems. 5. Will the current owner file bankruptcy? In the case of the John Hancock acquisition one of the key risks was that Broadway would file bankruptcy and the property would be tied up in court for years. In the meantime, tenants would leave the building and the Joint Venture would be stuck. To mitigate this risk, the Joint Venture looked at what are called the ―Bad Boy‖ provisions, which sophisticated lenders include in their documents and were present in this case. In order to keep owners from filing bankruptcy, the Hancock lenders included a provision that if Broadway filed for bankruptcy, the loans would no longer be non-recourse and the lenders could go after all the assets in the partnership. Sometimes these ―Bad Boy‖ provisions make the owner (or the guarantor) personally liable or otherwise create a strong disincentive.

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6. Try to utilize the UCC foreclosure process. In many states, foreclosing against real property is a judicial process that can easily take two years. It is not uncommon for the owner to divert rent from the property during this period, unless the lender has been able to secure the appointment of a receiver. In contrast, foreclosure through a UCC process is non-judicial and much faster. It can be as fast as ten days. 7. Final Thoughts: Five Mile brought significant distressed debt experience to the Joint Venture and has been successful at the ―loan to own‖ strategy, but each deal requires careful analysis of the legal risks, the timing risks and the collateral risks.

Endnotes

i Mark Feeney, “John Hancock Tower Overcomes Inauspicious Beginnings, Shines in Boston Skyline,” The Boston Globe, April 29, 2003. ii Ibid. iii Thomas Farragher, “60 Stories and Countless Tales”, Boston Globe, September 24, 2006. iv Susan Diesenhouse, “Layoffs create glut of space in Boston Area.” New York Times, February 5, 2003. v Thomas Palmer, “Towering Hopes Leventhal Sees Extraordinary return on record Hancock Deal.” Boston Globe, March 18, 2003. vi Terry Pristin, “Real estate deals to Flip Over.” , August 30, 2006. vii Barbra Murray,“Boston Trades Get Tougher, Costlier.” Commercial Property News, February 1, 2007. viii Michelle Hilman, “Downtown Landlords to Flex Muscle: Class A Rents Up Sharply in Q3.” Boston Business Journal, November 3, 2006. ix Casey Ross, “Rebuilding its fading image: New Owners vow changes will return iconic building to dominant position.” The Boston Globe, May 26, 2009. xx Casey Ross, “Rebuilding its fading image: New Owners vow changes will return iconic building to dominant position.” Boston Globe, May 26, 2009.

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