by Calculated Risk on 6/09/2008 10:29:00 PM

From the WSJ: Lehman's Property Bets Are Coming Back to Bite

Lehman joined with Tishman Speyer Properties last year to pay $22 billion for real-estate investment trust Archstone-Smith ... And ... it teamed up with Irvine, Calif.-based land developer SunCal Cos. to develop and sell thousands of house lots to builders across Southern California. ...

In both cases, Lehman dove into already heated markets, overpaid for the properties and, the firm says, has taken big markdowns. ...

In the deal for Archstone, which owns roughly 80,000 apartments ... Lehman put up $250 million in equity and led a group of banks that brought an added $4.6 billion in so-called bridge equity that the banks planned to sell to other investors. The banks have had trouble selling the equity as real-estate values dropped about 20% since then.

This deal was announced in May 2007, but wasn't closed until October - after the credit crisis started. I bet Lehman and their partners wish they had paid the $1.5 billion break up fee!

The Archstone-Smith acquisition was a negative cash flow deal from the start. To cover the interest on the $16 billion in debt financing, there was a $500 million interest reserve created. The WSJ notes:

As of the end of 2007, three months after the purchase closed and the latest numbers available, Archstone had already tapped $72 million of the reserve.

This suggests that Archstone is burning through the interest reserve very quickly. Not mentioned in the WSJ article was that Fannie Mae and Freddie Mac acquired a total of $9 billion of the $16 billion in debt. Something to remember if this deal really goes south.

Lehman's other troubled deal was with SunCal to sell house lots to builders in California, including in the so-called Inland Empire east of Los Angeles, where land values have plummeted as much as 60% in some areas.

Land values have probably fallen closer to 80% in parts of the Inland Empire. I've heard of bids right now at 20 cents on the dollar for some of these properties.