It’s an old story. A fancy apartment building gets built with a federally insured mortgage in the go-go ’80s. The project goes into default. The government-meaning you and me-coughs up millions to pay off the loan.
But wait. In one glitzy Gold Coast project, a typical concoction of the decade of greed, that scenario didn’t happen-though it almost did.
And the combination of historically low interest rates and reviving investor and lender interest in some areas of real estate-particularly apartment buildings-is enabling the government to save public money through more and more such deals, according to the Department of Housing and Urban Development.
In the Chicago case, the recently announced $32 million settlement of a foreclosure suit involving One East Delaware, a 37-story apartment tower, likely means a multimillion dollar break for taxpayers.
The 306-unit building, which opened in 1990, was developed by a partnership of real estate investors Thomas McCarthy and Richard Kahan and architect James Loewenberg.
They got a $35 million mortgage which was 85 percent insured by the U.S. Department of Housing and Urban Development under a Reagan administration program called co-insurance. Co-insurance allowed lenders to get heavy government backing for loans without having to go through all the HUD approvals that full insurance requires.
That program, which was terminated in 1990, funded some 1,400 apartment projects around the country. About 30 percent of them have defaulted on their loans, according to HUD.
One East Delaware, which was one of the costliest projects done anywhere under co-insurance, turned out to be one of the losers.
Starting in December of 1992, the partnership began to default on monthly mortgage payments of $249,000.
It also missed a property tax installment of close to $1 million.
“Economically this wasn’t really a distressed property, it just couldn’t quite make its existing mortgage payments,” insisted Loewenberg, pointing out that the apartment units were almost fully rented. “There is a difference.”
Loewenberg said the interest on the loan was too high. Another reason for the default was difficulty in leasing the five floors of commercial space in the building.
In any case, Maryland-based Integrated Funding, which had taken over the note from the original lender, filed a foreclosure suit in February of 1993. In response, the partnership filed for bankruptcy, a tactic which puts foreclosure suits on hold.
The stage was set for a sting on the taxpayers, such as happened with a very similar apartment building at 1212 N. LaSalle that was was developed under the same HUD program in 1988 by some of the same investors, including Loewenberg. It also had the same mortgage holder, Integrated Funding.
That building went bust and was sold at auction in the fall of 1992 for $13 million less than the mortgage value to condo king Nicholas Gouletas.
HUD got stuck with most of the loss.
But One East Delaware’s timing was better. By the beginning of last year, when it went into default, the low interest rates and stirrings of new multifamily investment activity enhanced the possibilities of a loan workout.
Loewenberg said the bankruptcy filing by his partnership, State/Delaware Associates, “was a device for getting the lender’s attention so it would negotiate on a sound business basis.”
The negotiating went on for almost a year, and during that period another lender was found that would take over the $35 million mortgage from Integrated for a discounted price of $32 million. The interest rate has also been reduced by about 1 percentage point.
“In every (other) case you can’t find sombody else to refinance,” said Sidney Kaplan, a Baker & McKenzie attorney who represented Integrated Funding. “In this case, they were able to go out and find another lender to take us out.”
The original mortgage is still co-insured by HUD, which is still liable should the building continue to have financial problems.
But Loenwenberg said the lower interest rate and an improved market will keep the project solvent.
The apartments are still almost fully rented, while the commercial space is 80 percent leased, he said.
“We’re now on a sound economic footing and should not lose any money,” he said.
A HUD official connected with the co-insurance program said the agency, which has to approve the deal, agrees with that assessment.
“Our determination is that it will stabilize, and though it may not happen immediately, the hemorrhaging can stop,” said the official, who declined to be identified.
He said that the main reason was the lower interest rate, and that the majority of co-insurance program defaults are being saved from foreclosure for that reason.
He added that many of the co-insurance deals that went into foreclosure a few years ago could probably have been saved if they were able to use today’s interest rates.
“They were ahead of the (rate) decline,” he said. “There was no refinancing possible at the time.”
