What happened to the W Union Square?

December 9, 2009
this, in the WSJ:

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There are two reasons why it’s hard to report clearly on things like the foreclosure auction of the W Union Square. The first is that there is a very complicated capital structure, which journalists have difficulty explaining. And the second is that it’s really hard to resist ledes like this, in the WSJ:

Dubai World’s private-equity arm ponied up about $282 million in 2006 for the trendy W Hotel Union Square in Manhattan. At a foreclosure auction Tuesday, the winning bid was $2 million.

This is the kind of thing which is literally true, but in all other senses false. Dubai World has not lost $280 million on the hotel, the hotel is not worth $2 million, and indeed the two numbers refer to entirely different things: the first is the total value at the top of the market for the mortgage, mezzanine debt, and equity combined; the second is the amount of mezzanine debt that an investor is swapping into a new equity tranche.

The Real Deal, has less color and much more detail — detail which is great for debt-market professionals, but which just gets confusing for the rest of us. Bloomberg, meanwhile, spends a lot of time talking about Dubai, which tends to obscure the details of what’s happening with the hotel. But if you put them all together, you can work it all out.

Basically, Dubai World (or its investment arm, Istithmar) paid $282 million in total for the hotel, and took out a $115 million mortgage. Istithmar put down $50 million of its own money, and borrowed the rest in what’s known as a “mezzanine” transaction: $117 million of high-yielding debt which isn’t secured against the property.

The mezzanine debt itself is broken into three tranches, which needn’t concern us right now. Suffice to say that what happened yesterday was a debt-for-equity swap. LEM had $20 million of mezzanine debt, and swapped $2 million of its that into 100% of the equity in the hotel, which was valued in the auction at $2 million. So Istithmar’s $50 million of equity has been wiped out, and LEM now owns the hotel, and is responsible for servicing the $115 million mortgage and also the $115 million $97 million of remaining mezzanine debt, $18 million of which it owns itself.

If you want to put a value on the hotel, it’s probably $115 million of mortgage plus $115 million $97 million of mezzanine debt plus $2 million of equity plus an unknown amount of past-due debt: call it somewhere in the $240 million $215 million range. That’s about a 15% 24% decline from the top of the market: a significant drop, but nothing particularly out of the ordinary. And most of the hotel’s lenders will be made whole, at least for the time being; the only exception is LEM, the new owner.

Lots of people are extremely worried about commercial real estate at the moment, saying that it’s the next shoe to drop. But a $240 million valuation still works out at almost $900,000 $800,000 per room, which is still a lot of money for a hotel which no one likes very much. The W Union Square is one of those creatures of the boom years: glossy and expensive, with no real soul. My guess is that its value has quite a bit further to fall yet.

Update: I’ve had second thoughts about how this deal works, and have updated the numbers accordingly. But the broad gist is unchanged.

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