CHICAGO -- Sears Tower, once the biggest real estate trophy, has turned out to be made of fool's gold.
The pension funds that invested $240 million in the 1989 refinancing deal will receive just $110 million from last week's sale of the tower.
Their investment was part of an $850 million refinancing of the tower that was put together by Boston-based AEW Capital Management Inc. for its AEW Partners Fund.
Pension fund investors in the partnership include Ameritech Corp., Eastman Kodak Co., International Paper Co., AT&T Co., IBM Corp., BellSouth Corp., Atlantic Richfield Co. and the retirement systems for the states of Connecticut, Iowa, Massachusetts and Michigan.
The pension funds were passive investors because AEW had discretion for the investments.
The buyer, TrizecHahn Corp. Inc., a publicly traded Canadian property company, paid $70 million for the partnership's interest in the trust, and $40 million for a parking garage next door.
AEW probably averts a larger loss on the investment by selling now to an investor with pockets deep enough to repay a senior mortgage to Metropolitan Life Insurance Co. that has ballooned to $734 million from $600 million in 1994.
MetLife's loan was a straight mortgage prior to a 1994 restructuring that converted it to a cash flow mortgage with interest payments deferred to 2005.
Interest totaling $134 million has accrued since the restructuring and continues to grow.
"The capital markets were favorable right now," said Thomas Nolan, a managing director with AEW. "Would it be when it came out of the grantor trust in 2003?
"I assigned a high degree of risk to having to operate in that window," said Mr. Nolan.
"They (TrizecHahn) will have tremendous flexibility to deal with this," Mr. Nolan said. "That (MetLife payment) weighed on us going forward."
As part of the restructuring, which occurred when Sears stopped making mortgage payments, AEW Partners' subordinated debt position was converted to equity and its ownership interest was held in a trust. The investors would take control of the tower in 2003.
Selling the tower now also improves the performance of AEW Partners, arguably the first opportunistic fund invested in by pension funds. The partnership closed in 1988. The Sears Tower was the partnership's largest single investment, and as a result, disproportionally suppressed its returns, said Mr. Nolan.
The partnership has returned a little more than 9% since inception, although the recent sale of the Sears Tower and other investments is expected to push it into the 10% range by the end of the year, said Martha Thurber, a director with AEW.
TrizecHahn is betting the tower will be a better performer, and that it will be worth more than the mortgage that is due to MetLife in 2005. AEW wagered in 1989 that it could re-lease a mammoth downtown corporate headquarters that was being abandoned for the suburbs by the parent company, with multiple tenants, said Martha Thurber, director with AEW Capital Management.
"The bet you are making is you will be able to re-lease the space at a higher rate going forward," said Ms. Thurber. "The downtown (Chicago) market was hit hard in the early 1990s."
AEW folded its cards in 1992 when it marked the investment down to zero. The tower was 53% occupied when the mortgage was restructured in 1994. The partnership previously had received interest income from the mortgage.
If TrizecHahn has made the correct wager, its payoff will be substantial.
"We are buying for $70 million, an $800 million asset," said Laurie Ludwick, a TrizecHahn spokeswoman. "There is also an opportunity to build value by refinancing the mortgage at a lower rate.
"The garage has development potential as an office building."
The tower, said Ms. Ludwick, is now 91% occupied, although the rents are 40% below the market rate.
"If we took those rents and marked them to market, it is a $1.2 billion asset," said Ms. Ludwick. "There is a lot of leverage, but it is appropriate for this asset."
MetLife was mum about the possibilities of again refinancing its mortgage. The insurer agreed to defer interest payments in 1994, and it allowed AEW Partners to retain an equity interest in the tower when it easily could have muscled the pension fund investors out of the deal.
"They (the borrower) have to meet certain requirements to get the extension," said James Lipscomb, senior vice president, real estate investments for MetLife. "It's equivalent to the normal criteria of debt service coverage and loan to value ratios that would need to exist if one was making a loan on a property."