Investment bank Lazard Freres & Co. had been negotiating to buy property

In what may be the most high-profile real estate deal to unravel amid the uncertainty caused by insolvent dot-com tenants, the $260 million sale of J.H. Snyder Co.'s Water Garden II in Santa Monica has fallen through, real estate sources said.

"The buyer backed away," said Howard Sadowsky, vice chairman of Julien J. Studley Inc., who thinks Snyder will go with another buyer within three months.

Developer Jerry Snyder has admitted shopping the building around but said last week that he was never under any contract to sell the 600,000-square-foot complex in L.A.'s hottest leasing market.

However, real estate sources said the real estate arm of New York-based investment bank Lazard Freres & Co. had been in the process of buying Water Garden II. Officials with Lazard Freres Real Estate Advisors declined to comment.

Few local real estate observers were surprised by the news, in light of the amount of sublease space that has poured onto the Westside market in recent weeks and the increasing concerns about a widening economic slowdown.

Water Garden II, though fully leased back in October, now has more than 20 percent of its space on the market.

"The marketplace has definitely shown signs of weakness in the past 60 days," said Ian Strano, senior vice president at First Property Realty Corp. "It's happening every day. A lot of deals are falling out of escrow right now."

High rents had pushed the Water Garden II's estimated sale value to $430 per-square-foot, or $260 million. But the calculations used to reach those numbers, based on rental income, may not reflect the reality of the market.

Previous demand for space by dot-coms has pushed leases at some A-list sites into the stratosphere. But now that the demand has softened, other Westside complexes like MGM Plaza and Water Garden I have seen growing amounts of sublease space go on the market.

"Some of those tenants are not strong, and a letter of credit doesn't help you when you're in a sinking market," Strano said. "(Landlords) got very high rents in a frenzied market, but that doesn't mean those rents will continue to escalate over time."

Water Garden II leased up at an astounding rate over the past year, as the incredibly tight Santa Monica market shot past Westwood to become the office submarket with the lowest vacancy rate.

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