Last week the media reported that a NYC skyscraper sold for about $600 million, and according to Real Capital Analytics the prior purchase price was $1.74 billion. The property has 1.8 million gross square feet, 1.6 million rentable square feet, and is 50% vacant.

From the information provided by the media, one would conclude the new buyer stole the property. After all, the property was purchased at a 65% discount from its previous purchase price only 2.5 years ago. For the naive, the story would end there and open the door to believing they found the deal of the century. Before running out to buy the next property at a discount to its previous purchase price, or giving money to a proclaimed bottom-feeder buyer, let’s look at all the facts.

The New York City rental market is no different than other real estate market sectors. Vacancies are high and rents are declining. The subject property is 50% vacant. Given that fact, it is reasonable to presume that the property is generating an operating negative cash flow. Even if the property were bought for all cash, when you add back concessions, the property would be generating an operating negative cash flow. By any logical standard, any operating business with a negative cash flow is a failing business. In other words, the buyer spent $600 million for a failing office building business.

The overarching question is: What do the new owners need to do to convert their failing office building business into a successful one? The obvious goal is to increase the percentage of leased space from 50% to 95%. Not impossible, but very difficult. Following are some realistic scenarios. Increasing occupancy in 10% increments per annum means it will take five years to get there. To accomplish this, the buyer needs to be prepared to spend a significant amount of capital. These costs will include tenant improvements (TIs), leasing commission, and negative cash flow.

Tenant Improvements

New lessees never say the space is perfect. In weaker markets, lessees are more demanding and the lessor pays. To get to 95% physical occupancy, 360,000 square feet need to be leased. The going rate for TIs is in the area of $125 per square foot. That comes to approximately $45 million.

Leasing

Leasing agents charge 6% of the rent to be collected for the length of the lease. In a weaker market it might be 5%. If the buyer could get $50 per square foot per annum with a three-year lease, that would amount to approximately $3 million in commissions paid up front.

Negative Cash Flow

What makes this category fascinating is the impossibility of projecting other than losses will be large. The buyer only hopes that they are not larger than the money set aside to cover them. It will be in the millions per year.

Conclusion

The bottom line is the buyer paid $600 million for a failing speculation. Assuming the economy cooperates and concessions aren’t a factor, what can the investor expect. Using the numbers above, and a 6% capitalization rate, the property could be worth approximately $750 million in five years.

An interesting side note would be who received the leasing commissions, property management fees, insurance commissions, and capital improvement oversight fees? The real question then might be: Was it a good buy or a bad buy, and for whom?