With Josh Beroukhim, Full-time real estate investor & owner of Bridge Properties, Founder of BehindtheDeals.com
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Turnberry’s Ill-fated Fontainebleau Hotel Development
Josh Beroukhim publishes articles analyzing and drawing lessons from high-profile real estate deals on his website behindthedeals.com. He joins Steve to talk about a recent piece he wrote on the Fontainebleau Las Vegas, a hotel which the development firm Turnberry Associates nearly completed in 2009, only to have the project stopped cold and the company bankrupted when its lender, Bank of America, called in its nearly $3 billion loan.
The story begins with Turnberry’s purchase in 2005 of the iconic Fontainebleau Hotel in Miami Beach. The company’s plan was to make $1 billion in renovations to the Miami Beach property and simultaneously build a 4000 room sister hotel in Las Vegas. The Fontainebleau Las Vegas hotel broke ground in 2007 and just two years later, with the property 70% complete and more than $2 billion dollars spent on building costs and improvements, the project came to a crashing halt. With about $800 million left to complete the hotel and the real estate and financial sectors in free fall, BoA decided to kill the remainder of its loan to Turnberry. What happened next, when Turnberry found itself in Miami Bankruptcy Court, is where the deal that Beroukhim’s analysis keys in on is first struck.
Icahn Buys The Fontainebleau Las Vegas Out Of Bankruptcy
In bankruptcy court, Turnberry was forced to sell the Fontainebleau Las Vegas to the highest bidder. While there was a lot of interest in this opportunity, in the end only three bids were submitted, and the only one of those which qualified was hostile takeover legend Carl Icahn’s offer of $150 million. Just on the cost of the lot itself, Carl Icahn scored big, paying only $6 million an acre for primetime land that Turnberry had paid $34 million an acre for. Considering how much money Turnberry and Bank of America had sunk into the hotel, the discount Icahn scored was obviously deep, but Beroukhim lays out the nuts and bolts of the deal’s value.
Fast forward momentarily to 2016 when Icahn hired a brokerage firm to list the still unfinished hotel at $650 million—which observers believed he would get, plus or minus 5%—to get a glimpse of the windfall involved. Backtracking, Steve asks Josh whether Icahn had plans improve or finish the hotel and then resell it. His answer is that, from the beginning, Icahn’s plan seemed to be to hold onto the property in its unfinished state and sell it when the market improved. In fact, he went even further than that, auctioning off all the furniture, mattresses, beds, wallpaper, and carpets for about $5 million, pennies on the dollar deals for its buyers. Steve observes that this looks like it was taken from the playbook of Icahn’s infamous corporate raiding years, buying distressed companies and stripping their assets and selling the remains. In this case, Icahn clearly had no interest in owning Las Vegas real estate or operating a hotel.
Breaking Down the Deal, Icahn Wins Big
So far, the salient details of the deal are that Icahn paid $150 million for the property, sold $5 million worth of furniture, and is going to sell it for around $650 million, but Steve asks Josh to walk him through his analysis and break the numbers down further. For starters, Beroukhim responds, there were acquisition costs of about $2.5 million for due diligence costs, closing costs, and legal fees. The annual “carrying costs”—unavoidable expenses like property taxes, insurance, and maintenance—Josh calculates at $5 million/year, which comes out to around $35 million for the 7-year duration that Icahn has owned the property. There was also a one-time cost of $1 million to cover the building in a special tarp, required by the city that considered the unfinished hotel an eyesore. Steve wonders what Icahn’s ballpark rate of return will be once the property is sold, and Josh estimates that on an all-cash approach (meaning Icahn didn’t need to borrow any money to pay for the property and associated costs) the return will be about 20% compounded annually. This kind of return is not often seen on a scale like this; Icahn is sitting pretty, to say the least. But it gets even better for Icahn: the tax write-offs for operating expenses and depreciation adds another $4.5 million in annual tax savings.
Developers Beware of Financial Risk
Beroukhim also addresses the question of what sort of lessons can be drawn from the story of this deal. One of the main ones is that ground-up development (as opposed to acquiring and renovating existing buildings) carries with it a special risk, a financial risk. Developers rely on banks for financing which can—as with the Fontainebleau Las Vegas—dry up at any time, even during construction. Banks don’t like to “call in” loans like this, but if the external situation is dire enough, say, a major market crash and recession or, for some other reason, the bank loses faith in the developers ability to finish the project and repay its debt, that is exactly what they may do. Josh’s advice for developers is to always consider the worst-case scenario, which looks a lot like Turnberry’s fate: insolvency and a massive project left unfinished.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: My next guest is a young man and a full time real estate investor. He’s the owner of Bridge Properties, and he’s also the founder of a website by the name of behindthedeals.com. And it’s a website where he analyzes high-profile real estate deals and extracts the practical lessons for his readers.
I’m pretty impressed with his work, and I asked him to join me today to discuss just one of his articles profiling a fascinating purchase by Carl Icahn of a busted Las Vegas hotel deal that was purchased after the crash of 2008. His name is Josh Beroukhim, and he’s with me today.
Welcome to the show, Josh.
Josh Beroukhim: Thanks for having me on.
Steve Pomeranz: So, a lot of my listeners are in South Florida, and they’re going to know the name of this deal because it was from the people who bought the iconic Fontainebleau Hotel in Miami Beach. And this was the Fontainebleau of Las Vegas which they were trying to develop.
How did this story begin? Who were the players, and how did Carl Icahn get into the mix here?
Josh Beroukhim: Sure, this story begins in 2005, where Turnberry Associates, a South Florida-based development company, acquired the Fontainebleau Miami Beach. After it acquired the Fontainebleau Miami Beach, Turnberry Associates planned a billion-dollar renovation of the Miami Beach hotel along with a brand new 4,000 room sister hotel on the Las Vegas strip.
After two years of planning, in 2007 the hotel in Las Vegas finally broke ground. Two years later, in 2009, the project went bankrupt, and the opportunity moved to Miami Bankruptcy Court.
Steve Pomeranz: Yeah, so hold on. Let’s take a step back here because a lot of people will know about Turnberry, the Turnberry Isles is a big project, of huge community in Aventura in North Miami.
So, these are the same developers of the properties there, and they decided after they bought the Fontainebleau in Miami Beach, they decided to have a sister hotel in Vegas and call it the Fontainebleau of Las Vegas. How much did they end up spending on this thing?
Josh Beroukhim: During the first two years of construction, they spent $2 billion, and at the time that the project went bankrupt. It was estimated that it had about $800 million left to go.
Steve Pomeranz: Yeah, so they spent $2 billion. Now, they bought it right at a point when Vegas was doing extremely well. Their gambling receipts had been growing by double digits each year, the population had been growing. And I mean, it was the hot place to be, so there was a lot of building going on, it seemed like the perfect time, and then the 2008 crash happened.
And you write in your article that Bank of America basically said no more, we’re not gonna lend you the money to finish the hotel, right?
Josh Beroukhim: Right, Bank of America had a commitment to lend the remaining $800 million for the project to be completed. But they decided that, considering the state of the economy and considering the bank’s finances, they backed out of their commitment and they left Turnberry Associates hanging.
Steve Pomeranz: Yeah, and I guess Turnberry Associates couldn’t get another lender, they couldn’t find anybody to finish the project. They had 2 billion in and to purchase it plus, I think they were about 70% complete, so they had put quite a lot more money into it. And since they couldn’t finish the property, they went bankrupt in Miami Court.
Is that where Icahn stepped in?
Josh Beroukhim: Yeah, so Carl Icahn very aggressively pursued this opportunity from the second it seemed that it was entering bankruptcy. 157 parties expressed interest in the Fontainebleau opportunity. Out of those 157 parties, only 8 signed confidentiality agreements to be able to review very detailed information about the property.
Ultimately, three bids were submitted to the Miami Bankruptcy Court, but Carl Icahn’s bid was the only qualified bid and, therefore, it was accepted at $150 million.
Steve Pomeranz: So, originally Turnberry associated paid $2 billion plus improvements, and he picked up this property which was 70% complete for 150 million, is that right?
Josh Beroukhim: Actually, Turnberry Associates, way before 2005, they built two residential towers behind the Fontainebleau Las Vegas hotel. So, at the time that Turnberry acquired the Fontainebleau Miami Beach, Turnberry already owned the 24 and a half acres of land on the strip.
Steve Pomeranz: Yeah.
Josh Beroukhim: But after acquiring Fontainebleau Miami Beach, and proceeding to build a hotel, $2 billion were invested in constructing the partially built hotel that kinda sits there.
Steve Pomeranz: Wow, so back then, you write that the cost of the land when Turnberry was buying it…I mean there was one hotel, the New Frontier Hotel, that went for $1.2 billion, which was $34 million an acre… but Icahn’s purchase price was just a bit over $6 million an acre, it’s astonishing really.
Josh Beroukhim: Yeah, it’s pretty interesting what a market cycle can do to the value of a property.
Steve Pomeranz: [LAUGH] That’s one of the warnings, I’m sure you’re gonna have at the end of this discussion about investing in real estate. So, he got 70% complete. Now, what was his plan, looking back on it and trying to figure this out?
Was his plan to buy it, improve it, finish the hotel, and then resell it, or did he do something differently?
Josh Beroukhim: From the get go, it seemed that Carl Icahn planned to just hold the property in its current situation and wait for the market to improve. He really didn’t make any attempt to spend even a dollar on the property.
He actually went off and immediately auctioned off all of the building’s furniture, mattresses, beds, wallpapers, carpet. He just tried to get all the money he could out of the existing improvements, which is a big vote of not having confidence.
Steve Pomeranz: Yeah, so he was just treating it like a distressed company that he would buy on the New York Stock Exchange, hold it for a while, and then wait for conditions to improve and then resell it. He was not desiring, I guess, to be in the real estate business, to be a Vegas real estate owner. So, he spent $150 million and I think he got about $5 million, was that correct for all the furniture and the carpets and the wallpaper?
Josh Beroukhim: From reading a few articles online, that was my estimate. One of the most prominent buyers of the furniture was the Plaza Hotel in downtown Las Vegas, which, based off of a few articles, seemed to transform itself into a luxury hotel just by acquiring the Fontainebleau furniture.
Steve Pomeranz: They must have been happy.
Josh Beroukhim: Which was a pretty interesting read in itself. Yeah, they seemed to be very, very excited about being able to acquire all the furniture.
Steve Pomeranz: Yeah, so he was getting rid of the furniture, trying to lower his cost. And they were picking up furniture for pennies on the dollar.
When distress hits these markets, a lot of these interesting deals come out. So, I understand that there is information that he is looking to sell the property now. What is he looking to sell the property for?
Josh Beroukhim: In November 2016, he awarded the listing of the property to a brokerage firm CBRE. And based off of a few articles I researched online, it seems that the asking price is approximately $650 million. And people assume that it’s gonna be selling within 5% of that price.
Steve Pomeranz: My guest is Josh Beroukhim, and he’s written an article about this deal. He’s the Founder of behindthedeals.com, where you’ll find more articles about high-profile real estate.
We’re gonna get into some of the numbers here, Josh. So he purchased the property for $150, he got a couple of million, or $5 million, whatever it was, for selling off the furniture. Now he’s listing it, some nine years later, or eight years later, for $650 million. You think he’s gonna get a price within 5% of that.
That sounds like a pretty good deal, but let’s break down some of the numbers here, cuz I think my listeners would be interested to know really how this stuff works. And how you kind of figure out what the rates of return are, and how you figure this out.
So, you actually did this work in your article, which I really loved. And so, let’s go through some of the numbers. The purchase price was $150 million. Now, there were acquisition costs to buy that. What do you estimate those would be?
Josh Beroukhim: We estimated those to be about $2.5 million, which included due diligence costs, closing costs, legal fees
Steve Pomeranz: Okay, so-
Josh Beroukhim: And other costs to acquire the property.
Steve Pomeranz: All right, so you said $152 million, 500. What about carrying costs for the property? I mean, we all have to pay property taxes, insurance, and maintenance. What did you estimate that that was for each year?
Josh Beroukhim: We estimated that at $5 million a year.
Steve Pomeranz: Okay, so over a seven-year period or so that’s $35 million. We got the proceeds of the furniture that’s in here. Other expenses, yeah, I guess the city demanded that since it was an eye sore, that he cover the building, I guess with a special tarp or whatever they do, and you estimate that cost a million bucks to do.
Josh Beroukhim: Correct.
Steve Pomeranz: And then, when you take the sale price, you put it at 625 million, less commissions of 25 million, that’s a good business to be in, don’t you think? [LAUGH] That’s nice commission. And when you estimated that, what did you estimate his actual rate of return considering all the money in, all the money out, the timing of all that money, what did you figure?
Josh Beroukhim: Considering an all-cash approach, we projected a return of approximately 20%
Steve Pomeranz: Per year.
Josh Beroukhim: Per year, a compounded return of 20% per year.
Steve Pomeranz: That’s pretty spectacular. I mean, it’s one thing perhaps to make that with a small amount of money, but a $150 million purchase is pretty, pretty difficult to do, right?
Josh Beroukhim: Absolutely, also considering the bare minimum work that Carl Icahn did to the property, makes it even more impressive.
Steve Pomeranz: Right, now there’s another boon here for him, and that is that there were tax savings on all of this. Tell us a little bit about how much you think he would have saved in taxes because real estate has certain tax advantages, and he gets to write off a lot of these expenses. Tell us about that.
Josh Beroukhim: Right, real estate investors can deduct operating expenses of a property and depreciation expenses from their annual income. So, based off an all-cash purchase, considering the $5 million of annual holding costs, that would be $5 million that would be deducted from taxable income.
Also, considering the value of the improvement on the property, we projected that approximately $3 million a year of depreciation can be deducted from his income. So, based off of that $8 million, by which his taxes would be lowered, that would result in a $2.5 million annual tax savings based off of a 35% tax rate.
Steve Pomeranz: And that’s annual?
Josh Beroukhim: That’s annual.
Steve Pomeranz: Right, so multiply that times I guess 6 or 7, you’re talking about $13 million. So, his annual tax savings you think are about $4.5 million then?
Josh Beroukhim: Correct.
Steve Pomeranz: Not bad, so I guess if you added that to the $625 million or whatever the sale price is with all the expenses, that brings his rate of return even above the 20% annual.
So, let’s talk about some of the lessons that we can learn from this. By the way, I’m speaking with Josh Beroukhim, he is the Founder of behindthedeals.com. Let me know if you guys listening out there, like this kind of information. I’ll do more of this, but I found this fascinating to see how these deals get done in the real world and some of the things that we can learn from it, which are lessons that we can apply to all investing, whether it’s real estate or other kinds of investing. So, let’s talk about some of those lessons. The lesson number one, understand the risks and the challenges of ground-up development, renovations, and expansions of existing hotels. Or rather, compared to the fact of just renovating and expanding an existing hotel, which may be a less risky option. Tell us about that.
Josh Beroukhim: Yeah, sure so, ground-up development brings with it several risks that don’t come with acquiring and renovating existing buildings. One of those risks is financing.
Developers rely on banks to provide financing during a construction project which, as in the case of the Fontainebleau of Las Vegas, can stop at any time. So, developers need to consider what’s the worst-case scenario if the financing dries up. Often times that worst-case scenario is insolvency and the project stopping in its tracks.
Steve Pomeranz: That’s a big risk because now you’re talking about not just the loss of some of your money or a fluctuation in the value of your money, you’re talking about a real loss. If you go into bankruptcy, pretty much, you lose everything. But, I also think one of the risks that is important here, is that, whenever taking out a bank loan for anything, remember that banks can call their loans.
They normally don’t do that, they normally don’t wanna do that. But in times of difficulty, of deep recession or whatever, they may just say no and they may just say, “hey, we want our money back and we want it right now,” so you have to be very, very careful.
Hey, Josh, unfortunately, we are out of time. My guest is Josh Beroukhim, again you can find this deal and other deals at behindthedeals.com. Josh, this was really informative, and I look forward to reading some more of your work and having you back on. Thanks so much.
Josh Beroukhim: Thank you so much.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
