There’s something refreshing about a slow-moving market in such a speedy world. At least there would be if it wasn’t commercial real estate, which is currently topping the 3am worry list of many investors and bankers.
Already facing the challenge of rising interest rates, the sector has been hit by fears since the collapse of Silicon Valley Bank and Signature Bank last month that weakening property valuations would be hurt further by a more conservative approach to lending by banks. Offices, affected too by the shift to working from home, have been at the centre of these fears.
In theory, the resulting losses could blow holes in bank balance sheets and wipe billions off investors’ portfolios. Blackstone, Brookfield and Pimco are among the big names this year to have defaulted on debts on offices in locations from Los Angeles to suburban Maryland.
It still could pan out as the worriers fear. But even that won’t happen at Wall Street’s typical speed where problems are identified, losses provisioned for, and executives move on in months. That matters for perceptions of the situation and its seriousness.
“Most workouts take years. And that applies to almost all situations,” says Stav Gaon, head of securitised products research and strategy at broker Academy Securities. Even if a borrower walks away, he says a so-called special servicer has to first officially foreclose. Only then does the property go through liquidation, which in many states, including New York, is pursued in the courts — and that takes a year or more.
Special servicers are appointed by bondholders. Lenders typically want to avoid taking control of a property if they can, since that means assuming operating responsibility which few are equipped to do. To avoid that, they, or special servicers when involved, can extend and modify loans if the borrower wants to hold on to the property.
The more groups that have to agree on any workout, the longer the process is likely to take. The biggest loans are often taken out by consortiums and are held by groups of investors, as in commercial mortgage-backed securities. That’s a lot of parties — including some individuals with big egos — that have agreed on value, strategy and acceptable lending terms.
Take for example Stuyvesant Town and Peter Cooper Village, an 11,000-plus apartment complex on Manhattan’s Lower East Side. Following the 2008 financial crisis, the owners led by developer Tishman Speyer first struggled, then walked away in January 2010. It wasn’t until 2015 that Blackstone bought the property.
Barclays strategists this week estimated that about 16 per cent of CMBS deals will mature by the end of 2024, while up to 23 per cent of insurers’ loans to commercial real estate are due in that time and about 25 per cent of bank loans to the sector.
“The office CRE problem is a slow bleed, not a big bang,” they concluded.
Property specialists are also generally sanguine, having weathered booms and busts in different sectors and locations.
“The reality is that maybe 30-odd per cent of mortgages come due over the next few years — but that’s been the case for as long as I’ve been doing this,” said Rich Hill, a two-decade veteran of the industry and head of strategy and research at investment manager Cohen & Steers.
The significance of weaker valuations depends on their timeframe. New York-based Vornado Realty Trust wrote down its share of 650 Madison Avenue by about a third at the end of last year. The 27-storey retail and office tower is one block east of Central Park and home to Polo Ralph Lauren’s global headquarters as well as luxury stores including Balmain and Moncler. It has $800mn of debt that runs to 2029, charging 3.5 per cent. When that was arranged in 2019, the building was valued at almost $1.3bn.
“Nothing says that over time, that value can’t go back up,” Michael J Franco, president and chief financial officer, told analysts on Vornado’s year-end earnings call.
Its clearly not all gleaming skyscrapers and sunlit uplands. Souring office loans will rise to as much as 4 per cent of the sector’s total in CMBS deals by year-end, from under 1.5 per cent currently, says Fitch Ratings.
Right now though, the gloom and the barrage of scary numbers can make it hard to see clearly.
“We’re hearing from investors who say ‘we’re not going to look at that deal because it’s got office exposure’ — and that’s regardless of whether the office is in Los Angeles or Miami, which is a very different story,” says Gaon, who likens it to investor jitters over shopping malls a few years back. “Until that headline risk passes, we’re not going to see much activity.”