Is iStar Sprouting A Portfolio Full of Contingent Liabilities?

iStar, the embattled Mortgage REIT, has been taking it on the chin recently. Last quarter, they set aside $217 million for bad loans, and a $45 million charge for mark to market losses. The REIT’s high profile developer defaults in Miami, the epicenter of the bubble, are already well-known. However, its new get tough policy with deadbeat borrowers may be starting to produce unintended “collateral” damage.

Magnolia Green Development LLC, the borrower under an $85 million construction loan, is alleging that iStar is improperly attempting to recall $24 million of the loan. The developers have filed a $250 million lawsuit, plus damages estimated to exceed $100 million, against iStar for allegedly illegally threatening to sieze control of the project. Magnolia Green is seeking a jury trial (which is unusual) and a declaratory judgment that they are not, in fact, in default.

The developers allege iStar is attempting to “lay claim to the project’s extraordinary projected profits…as a quick fix for its sagging balance sheet.” It said that iStar’s stock price had dropped dramatically to about $7 a share when the suit was filed, down from $47 in January 2007, when iStar made the loan.

The suit alleges that iStar’s “attempt to seize control and ownership of the Magnolia [Green] project have been motivated and influenced by defendant’s precarious and embattled financial and legal condition, including multiple legal actions pending against it.”

Curiously, iStar apparently evidently never declared the loan to be in default. According to the suit, iStar declared that the loan was “out of balance”. In letters to the developer dated July 17th and August 4th, iStar demanded that Magnolia Green deposit $24.3 million into the loan account and an additional $1.2 million into the interest reserve by August 21st. Magnolia Green refused, and instead filed suit on August 18th.

The disputed project is one of the largest in the country, a development of nearly 3,500 homes on 1,898 acres in Virginia with a large commercial and office component. Many of the homes, which range in price from $300,000 to $1 million, are already built or nearly completed, and homeowners are already living in some. The development also includes the Westham Golf Club, an 18-hole Nicklaus Design golf course. The work on the golf course is about 70 percent complete, the developers said.

Lifestyle Homes, the operating entity behind Magnolia Green Development, is no stranger to the legal system. After purchasing the huge tract of land in 2003 for $39 million, they successfully took the seller to court seeking monetary damages and specific performance under the purchase contract when the land was delivered without the required easements.

This dispute with Magnolia Green is but one high profile result of iStar’s new survival strategy, as it battles former clients in an effort to “aggressively take back the keys” on doubftul projects. In the last earnings call, iStar descibed a “higher beta” around loan loss recoveries than had been anticipated.

Unfortunately, as more of the REIT’s projects go into default, the potential for “contingent” liabilities like the potential $350 million claim from Magnolia Green dispute will increase also. The disclosures in iStar’s footnotes in this regard should be required reading for all iStar shareholders. Not only is management increasingly distracted by these workouts, but additional unforeseen balance sheet liability could also be lurking in the wings. [Update: On Sept. 27, Magnolia voluntarily withdrew the lawsuit. Neither iStar nor the developer would comment, but the lawsuit clearly provoked a settlement, likely involving a loan modification].

In other iStar news, the REIT has apparently found a buyer for the land it foreclosed on in relation to the failed $2.2 billion, three tower Brickell CitiCenter, which was to include the tallest building in Miami (not to mention 2400 condominiums) before the market there collapsed.

It’s unlikely that the buyer will proceed with the approved plans for condominiums, given the state of the Miami housing market. Tory Jacobs, president of the Brickell Homeowners Association, said he doesn’t know anything about the pending land sale, but he has an idea what he’d like there.

“It’s prime area, but obviously there’s overbuilding in residential,” he said. “I think we could use some sort of a retail complex that wasn’t fancy — maybe a Target or something.”