Sunday, February 12, 2012

Office-space speculators make a capital killing

"Money's tight for Pennsylvania. But last month, a state agency went to Wall Street and borrowed $107 million to enrich a California hedge fund, a Wall Street bank, and other speculators in a Harrisburg office building.

Result: Investors who bought bonds tied to the city's Forum Place at deep discounts are being paid full price to turn them in, giving them millions in profit.

But state officials say that's still a good deal for taxpayers - because the new arrangement will allow state workers to park their cars at a discount.

Our story opens in 1998, when the Dauphin County General Authority, one of the many local financing agencies that keep politicians and their bankers, lawyers, and advisers busy, raised $86 million - through bonds sold to Merrill Lynch, PaineWebber, First Union mutual funds, and Wilmington Trust - to buy Forum Place.

But in 2001, Forum's main tenant, PennDot, moved out. As rent stopped, cash for bond payments dried up. (The firm that arranged the financing, Dolphin & Bradbury Inc., was fined $800,000 by the Securities and Exchange Commission for not warning investors.)

As the bonds defaulted, investors cut their losses and sold at discounts approaching 50 percent. Most were bought by an arm of Saybrook Fund Advisors L.L.C., Santa Monica, Calif. Citigroup bought bonds with a face value of $12 million.

Saybrook found the building poorly managed. Comanaging partner Jon P. Schotz told me his firm went straight to work "fixing things the way we wanted, as opposed to the way those chuckleheads did."

Soon, Pennsylvania agencies were moving back to Forum Place. The authority's finances slowly mended, Schotz told me. "It would take them 10 years" to replace the lost bond payments, he said. "Maybe 15."

Investors didn't want to wait. They sued to make the authority pay faster. Commonwealth Court said no.

Saybrook kept recruiting tenants. In 2009, the state signed a 25-year lease to fill Forum Place.

A lease that long "happens very rarely. Generic office space is easily replicated. If you're leasing for 25 years, why don't you just buy it?"

But the Rendell administration tended to sell state office buildings (like the one in Philadelphia, to developer Bart Blatstein, for $25 million, later cut to $21 million), and lease private space instead.

Why lock in so long? "The reason we did the long-term leases, we were trying to consolidate space from a lot of smaller locations, in a more centralized master lease," James Creedon, who headed Gov. Rendell's Department of General Services, told me. Forum Place fit; Saybrook's price was a "long-term relationship."

After Gov. Corbett took over, Saybrook proposed that the state buy out Saybrook's old Dauphin County General Authority bonds, with payments equal to its old rents.

"The state didn't have any obligation to pay on the bonds," Schotz acknowledged. So Saybrook sweetened the deal: It gave the state control over parking, enabling it to avoid a threatened increase in Harrisburg parking costs, said Troy Thompson, spokesman for the state Department of General Services.

The deal also gave the state the right to buy the building for $1 at the end of its long lease if it wants.

The new bonds are issued by the Pennsylvania Economic Development Financing Authority. In a letter to Internal Revenue Service chief counsel William Wilkins, Mark Schwartz, a Haverford lawyer who helped draft the law that set up PEDFA, called the new bond a "perversion" of the agency's old focus on funding "small manufacturing entities."

Schwartz urged the IRS to review the bonds' tax status. He calls the deal "a bailout" for people who don't need one - inappropriate in a state intent on cutting costs."

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