Real estate investors who sought to acquire 11 state of California office buildings say they are watching with interest an unfolding legal dispute over the sale to a Hines-led consortium; some retain hope that they still may win the prize.
The $2.33 billion deal is caught in legal limbo in state appellate court in San Jose, following the successful appeal of a trial court’s Dec. 10 decision. The trial court ruling would have allowed the transaction to go through on Dec. 15.
The legal wrangling has forced the California Department of General Services to release the bid documents from the nearly 400 offers it received. The state seeks to sell the buildings, which are encumbered with about $1 billion in debt, then to lease them back. Before the lawsuit was filed Nov. 16, the state refused to make the records public until after the sale was closed.
The documents show that the offering attracted the interests of a wide range of investors and that the bids were in no way uniform, with significantly differing terms even among the 11 final offers. Several bidders proposed using financial structures to allow the debt to be tax free; others simply offered cash.
Among the finalists were the South Korean Military Pension Fund and the Military Mutual Aid Association Fund. The two offered $2.29 billion for the properties, but stipulated that the state pay a $10 million “consulting” and “advisory fee” to Euromart Realty Group Inc. and McKinley Infocapital Co.
San Francisco-based Stockbridge Capital Group partnered with J.P. Morgan to offer the state $2.015 billion in cash. The company emphasized its California “commitment,” including its relationship with the California Public Employees’ Retirement System and the California State Teachers Retirement System. It boasted that it is the largest “real estate only” investment manager headquartered in San Francisco and that it has $5 billion in institutional real estate assets under management. Newport Beach-based Craig Jarecki Kray Investments’ $2.2 billion offer was to be financed exclusively through Deutsche Bank.
Over the course of the sale process this spring and summer, the General Services department extracted nearly an additional $250 million from California First LLC, its selected bidder. The price increase depressed the trade’s capitalization rate, or initial investment yield, to 6.4 percent, down from the preliminary offer, which would have yielded a 7.1 percent going-in return. California First guaranteed to pay the state its offered price in cash the day of closing.
But the $2.33 billion bid from California First was not strictly the highest offer the state received. Moreover, its terms stipulate an outright sale of the 11 assets, which include several historic structures and the building that houses the California Supreme Court.
That sale provision, which is not universal among the 11 final bids, has emerged as the most controversial element of the deal. It is essentially what is motivating the legal challenge and is the subject of greatest conflict. Even as the General Services Department chose to sell the buildings, at least three of the final bids include a provision that would have returned the properties to the state at the end of a lease term.
Estimates of the buildings’ so-called “residual value” are as high as $1 billion, according to one bidder who asked not to be named. “The reversion factor has never been discussed. We felt it was shoved under the rug, and it was a huge number,” another bidder said.
The Golden State Acquisition Group, another finalist that included AEW Capital Management LP, said it would pay the state $2.3 billion for the portfolio, then return the properties to the state at the end of the lease term. The group estimated the portfolio’s residual value would be $850 million. QueensFort Investment Corp., another finalist, offered the state more than $3 billion for the portfolio and agreed to return it to the state for $1 at the end of the lease term. The offer discounted state rents in the first five years, then bumped them up for the succeeding 12.
The documents also show that the winning team did not include the Hines company in its first-round offer. It did include Beverly Hills’ Black Equities Group, the same company now seeking to gain control of a prime Silicon Valley building site via bankruptcy court in San Jose.
Hines, a global commercial real estate company that controls $22.9 billion in assets, replaced Black Equities as the managing partner, according to later bid documents. Hines, which has regional offices in San Francisco, has a long history of doing business with the state of California, perhaps most prominently as an investor on behalf of CalPERS, via its National Office Properties’ partnership.
Among the other members of the winning bidder’s team are Michael McCook, the former senior investment officer for global real estate investments at CalPERS, and Grover McKean, the former California deputy state treasurer who oversaw all debt issuance.
Whether California First will successfully close the $2.33 billion sale is, of course, an open question. For now, it appears a race against the clock as Gov. Schwarzenegger’s term expires early next year.
The appellate court has ordered the state and plaintiffs to file briefs in the final days of this month. Whether the appellate court will hear oral arguments—and when—is completely up to the court’s discretion, said Anne Marie Murphy, a lawyer for the plaintiffs.
A spokesman for the state, Eric Lamoureux, said its attorneys would file their opposition papers well before the Dec. 27 due date.