In a Pickle: How a Famous London Skyscraper Went From $1 Billion to Zero in Just Seven Years
In statistics, pictures of risk often take the shape of elegant bell curves. But in real estate, a better visualization of risk might be the elegant missile-like shape of the London skyscraper nicknamed the Gherkin, which has gone from being a darling of the city’s financial district to a menacing symbol of the excessive risk tolerance that fueled the Great Recession.
Formally known as 30 St. Mary Axe, the building was commissioned by insurance giant Swiss Re and was designed by architects Foster + Partners. At 590 vertical feet and 40 stories high, it’s the third tallest building in London. It opened in the spring of 2004 to global fanfare, but just five years later the building’s financial foundation began to crumble. Here’s what happened.
In 2007, the then-owner of the Gherkin, Swiss Re, sold the building to a fund managed by German real estate company IVG Immobilien AG and UK-based private equity firm Evans Randall Ltd. for £600 million (about $1 billion). The fund didn’t pay cash for the building. Instead, it got a £396 million loan from a group of German banks to make the deal.
That’s when the problems started.
IVG borrowed its portion of the loan in Swiss francs. The Swiss franc is well-known for its strength as a currency, and IVG was able to save 100 basis points on the loan’s interest rate by taking a franc-denominated loan. Of course, that meant making the loan payments in Swiss francs, and for German IVG, it meant purchasing francs in order to make those payments.
That and the fact that the collateral – the Gherkin – was valued in sterling created currency risk for IVG, and its short-term savings on interest expense turned into long-term headaches when the global recession went into full swing just a year after it bought the building.
The Great Recession helped fuel a 60% spike in the value of the franc, which effectively raised the value of IVG’s liability by £100 million.
Adding to the headache were falling interest rates, which caused some of IVG’s interest rate hedges to end up out of the money to the tune of £140 million.
And on top of that, property values were falling around the globe.
The combination of increased debt and decreased collateral value proved fatal. The debt ratios rose so high, they drove the borrower into default in 2009.
Ironically, cashflow wasn’t really the issue. After all, the building was and today still is full of paying tenants. Nonetheless, being overleveraged is being overleveraged, and when banks get spooked, bad things happen. In April, after five years of default and fruitless negotiations, German banks forced the Gherkin into receivership (the equivalent of Chapter 11 in the United States). In receivership, a court transfers the property to a receiver, which in this case is Deloitte.
Usually, receivers sell the assets in receivership, which is exactly what Deloitte decided to do this week. The Gherkin is now for sale again, this time for £650 million. The building was valued at £473 million to £510 million in 2012, according to one report.
Lessons: Avoid Currency Risk, Shiny Objects
The Gherkin’s financial story offers a few serious reminders to those of us who navigate the financial world every day. One of them is that shiny objects, whether real or in concept, can be dangerously seductive. The other is that currency risk is real, it is easy to acquire and it can absolutely pulverize a deal.