How City's Skyscrapers Hit Bottom
Seattle Times Staff Reporter
WITH THE SALE Friday of Key Tower to the city of Seattle, every significant building built downtown in the past decade has either gone broke, changed ownership or both. -----------------------------------------------------------------
When investment banking firms close big deals, say, a corporate merger or takeover, they buy advertisements in financial newspapers congratulating everybody involved, especially themselves.
In the late 1980s, many of these advertisements concerned billions of dollars being loaned to build high-rise office buildings all over the country. Every day, the pages of the Wall Street Journal and Investors' Business Daily were full of them.
Keith Riely, a real-estate appraiser who worked for lenders, said at the time that the "financial institutions were choking on cash."
"You could get money for almost anything," one Seattle developer said.
Lots of cash chasing not enough deals, the bankers would say. Money was backed up like so many minivans in a rainy Interstate 5 rush hour. It couldn't get where it wanted to go fast enough.
The investment-bank advertisements unvaryingly are the same size and rectangular shape and have nothing in them except the announcement of the deal. Because of their appearance, within financial circles these advertisements are called tombstones.
Today, downtown Seattle is a graveyard of big deals. The sale Friday of Key Tower to the city of Seattle is the last of a long list of development deals gone bad. The most prominent include:
-- Columbia Seafirst Center, built by Martin Selig in 1985; sold to its lender, Seafirst Bank, in 1989.
-- Washington Mutual Bank, built by Wright Runstad Co. in 1988; refinanced with majority ownership transferred to a General Motors pension fund in 1994.
-- U.S. Bank Centre, built by Prescot in 1989; deed lost "in lieu of foreclosure" to Seafirst in 1990; sold to PFC Holdings.
-- Two Union Square, built by UNICO in 1989; lost in foreclosure to the Washington State Investment Board.
-- Key Tower, built by Gateway Associates in 1990; sold at a heavy loss to the city of Seattle on Friday.
The city's purchase of the distinctive 62-story Key Tower as its prospective seventh City Hall at once pushes the city into the realm of skyscraper tenants and erects the final tombstone on an era of unprecedented development and unseemly financial demise.
Here's how it happened.
For a century, development in Seattle proceeded at what could charitably be described as a stately pace.
Downtown development was largely the province of the University of Washington, which owned 10 acres smack in the middle. That land is managed by a private company called Unico. Unico did not build new buildings, according to its president, Don Covey, until tenants asked.
"No-brainers," one local lender has called such build-to-suit buildings, which involve less risk. Seattle's entire development history was filled with no-brainers.
That changed in 1983.
"Off the deep end"
The modern era in downtown development began with Martin Selig's building of Columbia Center, a 76-story black tower that dwarfed everything else in the city, as it would have in almost any other city in the world.
Before Columbia Center, Seattle development was stately. Afterward, it was frenzied.
In the 1980s, developers built as much downtown office space as had been constructed in the previous 100 years. The boom was predicated on what turned out to be misplaced faith in a growing market and fueled by the ego of individual developers, each of whom repeatedly predicted the failure of the others.
N. Michael Beyard, an analyst for the Urban Land Institute, a developer's lobby group, said builders were "encouraged by the large quantity of money available. We've ended up with speculative buildings that may never be needed. They sort of went off the deep end."
Surveying Seattle's downtown office market in 1989, when four new skyscrapers were being finished, Jack Shaffer, a veteran New York investment banker, said:
"I am not the world's most optimistic guy about the Seattle market." This was after Shaffer had helped arrange the $165 million loan to build Key Tower, then known as Gateway, between Fifth and Sixth avenues and Columbia and Cherry streets.
These were development advocates, remember, speaking at a time of furious development. Their cautions proved to be wrong only by being too faint.
"The banks are going to take a haircut"
Local investor Herman Sarkowsky began developing Gateway Tower in 1979. Construction finally began in 1989. In between, four other huge high-rises were built. As the last one out of the ground, Gateway faced the stiffest challenges. It never met them.
The building opened in 1990 and was in default shortly thereafter. Its lead tenant, AT&T, radically changed its leasing strategies before it even moved into the building and began fighting to break its lease almost immediately.
Other tenants were scarce. Rents were half what had been projected.
The city could not have picked a better time to go shopping for a big building.
The city has offices spread out in more than half a dozen downtown buildings. Three - the Municipal, Public Safety and City Light buildings - have been determined to be structurally unsound.
City offices in those buildings occupied 750,000 square feet. Renovating that much space would cost more than building or buying new space, city analysts concluded.
In the fall of 1994, the city asked voters to approve a $122 million bond for a new public-safety building. The bond measure failed. The city re-examined its strategy.
A survey of existing available buildings was part of that re-examination. Key Tower, then called AT&T Gateway Tower, had the most space available and, although it wasn't being actively marketed, it was for sale.
Gateway's developers, a partnership of Sarkowsky, Canada's Belzberg real-estate family and the Japanese construction company Kumagai Gumi, were in default on their $165 million loan. Their lenders, led by the Bank of Montreal, wanted a sale to avoid a foreclosure and what they feared would be a long bankruptcy proceeding.
Unlike many other high-rises, Gateway was financed with a nonrecourse loan, meaning the banks would be unable to take control of other assets of the mortgage holders to satisfy the loan.
In other words, when the city went shopping for office space, the Key Tower lenders were ready to take what they could get, even though, as one participant said, "the banks are going to take a haircut on this one."
Haircut or not, the lenders wanted to recover what they could and get out.
"We're not in the business of owning real estate," said Lynn Kilpatrick, a Bank of Montreal spokeswoman.
The problem for the lenders was they couldn't sell what they didn't own. The Sarkowsky group, in default or not, still legally owned the building. They had the deed. It works this way, real estate brokers say:
The lenders say, I want to sell the building. But they don't have the building. They have the notes. They can go out and sell the notes.
They get killed when they do that, so the lender has to get the deed. They can do a foreclosure or they can ask for a deed in lieu of foreclosure. In other words, they ask the owner to just walk away.
The owner says, How much are you going to pay me?
Pay you? Why should I pay you? You owe me.
Because if you don't, I'll go into bankruptcy and you'll never get your money.
That's what happened in this case. The owners said, "I ain't giving it to you."
"They were expert in creating fear in the lender," one source said.
"You can't give away an empty building"
The people in the three corners of the Key Tower deal were not equally motivated. The lenders had the most urgency, since they had the most to lose. The city wanted the building, but could afford to wait. The borrowers had the least urgency, since they had already lost everything. So they were in no hurry to go anywhere and they had, sources say, an expert heading their negotiations, Neil Hokonson.
Hokonson, an accountant by training, came to Seattle in the 1980s to start a development office for First City Equities, the Vancouver, B.C., development firm owned by the Belzberg family. The Belzbergs are notorious within real-estate circles as hard bargainers.
"The Belzbergs are not that easy to deal with," one investment banker said.
"You say to them, `You want a dime; OK, here's a dime.'
"They say, `What we really meant was we want 12 cents.'
"So you give them 12 cents.
"They say, `Actually, what we meant was 15 cents.'
"You get the picture?"
Hokonson was First City's representative in the Gateway ownership and, according to everyone, learned the Belzbergs' lessons well.
Hokonson once described the process of building as simple. "You get a bunch of construction guys, architects and engineers, put them in a room and tell them to bring out a building. Then you keep saying no until they bring out what you want."
In the end, though, Hokonson's partnership lost most of its leverage once the city negotiated the price range with the bank last summer.
"The city got it at a pretty low price going in, then crammed it down," one participant said.
The eventual purchase price was not much more than 50 cents on the dollar it cost to build the building. This surprised no one. Office buildings have virtually no residual value. The sticks and stones of the building can't be sold. They are worth only what they produce in revenue. Key had never produced enough revenue to pay its debt service, so it had little value on the open market.
"You can't give away an empty building," one investment banker said.
The scarce tenants eventually cost Sarkowsky, his partners and lenders an estimated $85 million. The beneficiary of that loss for the moment at least appears to be the city of Seattle, which paid a rock-bottom price of $120 million for the building.
In its short life, the building at Sixth and Columbia has had three formal name changes, from Gateway, to AT&T Gateway, to Key Tower. Now, presumably it will acquire another name - City Hall.
Through it all, the name that rings truest was one given to it by Faye Sarkowsky, Herman's wife. During its development, as she watched the building wreck her normally implacable husband's mood and health, she began thinking of Gateway as "that goddamned building."
She changed her mind after it was built, saying it would henceforth be the "God-blessed building."
Maybe she was right the first time.
Published Correction Date: 01/21/96 - The Washington Mutual Tower In Downtown Seattle Is Owned By Wright Runstad And Co., Not A General Motors Pension Fund, As Reported In This Article. The Eight Buildings In A Refinancing Transaction Between Wright Runstad And The Pension Did Not Include The Washington Mutual Tower.
Copyright (c) 1996 Seattle Times Company, All Rights Reserved.