CMBS get to eat it all: Amid overvalued vacant collateral, there is a new thingy: Tenants delaying rent payments and landlords asking for forbearance.
By Wolf Richter for WOLF STREET.
The office segment of the commercial real estate market – and the debt and the commercial mortgage-backed securities (CMBS) that are backed by it – are going through serious gyrations on a combination of factors. Companies have figured out how to make work-from-home manageable. Other companies are moving out, leaving buildings vacant, or are deferring rent payments. Landlords whose cashflow from rents has suddenly crashed are failing to make their mortgage payments or are asking for forbearance. And CMBS are at the receiving end of the process.
That any return to the old normal for landlords, banks, and holders of CMBS is just a dream is now being increasingly accepted, including by Larry Fink, CEO of mega asset-manager BlackRock: “I don’t think any company’s going to go back to 100% of the workforce in the office,” he said at an online event. “That means less congestion in cities. It means, more importantly, less need for commercial real estate.”
This new era of office real estate comes on top of the problems currently erupting: Tenants moving out for nicer digs, now that there are plenty available, or tenants laying off people and possibly shutting down. So here are two specific examples of how this is bleeding into CMBS.
In Houston, the office vacancy rate has been above 20% for years due to the oil-bust that started in late 2014. It was 22% in Q1, according to JLL’s Q1 2020 report. The construction boom that was still in full swing in 2015 has put a lot of brand-new Class A office towers on the market with little demand, as oil companies have shed office space.
Developers have been trying to fill those new towers, and in doing so, companies have moved from their prior digs into superb new spaces – the “flight to quality.” JLL:
After the true scale of the COVID-19 crisis emerged, Houston market observers are thinking, “here we go again.” Already beset by five years of skyrocketing vacancy, Houston’s office market may be headed for a double-dip thanks to an ailing energy market and a worsening Coronavirus situation.
JLL called it the market’s “split personality”: “heavy demand” for new buildings “counter-balanced by generationally-high vacancy, weak tenant demand, and a palpable sense of unease from energy sector volatility.”
And JLL added that on top of the “already weak quarter” in terms of signed leases, “the first quarter was further exacerbated by a near halting of leasing activity in the last few weeks of March.”
This is the environment in which the debt behind One City Centre at 1021 Main St. in downtown Houston is blowing up. This 602,000-square-foot office tower backs $100 million of CMBS debt. The collateral was appraised for $162 million at the time the debt was packaged into CMBS in 2015. And now, it turns out, according to Commercial Real Estate Direct, citing estimates by DBRS Morningstar, the tower might be worth only $35.7 million.
The interest-only $100-million mortgage, which matures in April 2025, is split into two pieces that have been included in two CMBS, according to a note sent out by Trepp, which analyses CMBS: a $60 million piece that makes up 7.9% in JPMBB 2015-C29; and a $40 million piece that makes up 3.4% of JPMBB 2015-C30, which is a part of CMBX 9.
The 32-floor tower, which was completed in 1960 and was renovated in 2010, had an occupancy rate of 68% in 2019. Its largest remaining tenant, Waste Management, which occupies 40% of the space, decided to not renew the lease that ends in December 2020. Instead, it will move into the brand-new Capitol Tower a few blocks away.
Also a few blocks from the One City Centre is the 1 million-square-foot Texas Tower that is expected to be completed in 2021.
So that $100-million mortgage, spread over two CMBS, will be backed by an essentially empty older tower that cannot compete with the new and vacant towers sprouting up, and that may be worth about 36% of its debt – and about 22% of its last “valuation.”
This theme has been playing out all over Houston: New towers attract tenants from older buildings, and older buildings empty out and turn into hugely overvalued collateral. Creditors and holders of CMBS are starting to grapple with this.
In San Francisco, the nuances are different. It’s not the oil bust but the startup bust and the accompanying Softbank bust. So here is an example how that bleeds into CMBS.
The 54,400-square-foot five-story office building, built in 1984, on 55 Green Street in San Francisco’s North Waterfront submarket is the collateral for a $36.6 million loan, which was originated in late 2019 and now forms 3.2% of the collateral in the CMBS COMM 2019-GC44. It was put on the servicers watch list in April, according to a note sent out by Trepp, which added: “The watchlist comment noted that relief was being requested as a result of COVID-19.”
The sole tenant of this building is peer-to-peer car-sharing unicorn Getaround, which leased the space in October 2018, after it had received $300 million in funding, led by SoftBank. Getaround moved into the space in April 2019. In September 2019, Getaround raised another $200 million, led by SoftBank, with investors agreeing on a $1.7 billion “valuation,” according to TechCrunch. Fancy offices is the kind of stuff startup funding was being wasted on.
About four month later, in January 2020, long before the Virus started to wreak havoc among startups, Getaround became the latest SoftBank gem to implement mass layoffs, 150 people, about a quarter of its workforce.
By March 20, as Getaround was starting to run low on cash, sources told Bloomberg that if it could not find a buyer or obtain a cash infusion, it may consider filing for bankruptcy.
By March 27, Getaround cut another 100 people, or about another quarter of its remaining workforce.
The company’s days are numbered. And even if it survives in whittled-down form, it won’t need this much office space. With the only tenant gone, this entire building would be vacant and generate no revenue, and the mortgage in the CMBS would likely go into default.
The building had been purchased for $29 million in 2018 and then was “repositioned.” To make it look good to investors when the $36.6 million loan was securitized in 2019, the collateral was “valued” at $64.3 million, giving it an appealing but now likely fake loan-to-value ratio of 57%.
These types of scenarios are now playing out all over the country: Overvalued office buildings that are now losing tenants make up the collateral for mortgages that have been securitized into CMBS.
And in addition, many of those tenants that are staying are delaying lease payments. This has caused landlords to seek forbearance on their mortgages and has thrown the entire CMBS market upside down.
According to Fitch Ratings, in terms of all types of CMBS, not just those backed by office buildings, 5,420 conduit borrowers (landlords) have contacted their servicer seeking relief over the past 30 days, representing 17% of the $584 billion of the CMBS that Fitch had surveyed, based on data from the largest CMBS master servicers (Wells Fargo, Midland Loan Services, KeyBank National Association, and Berkadia Commercial Mortgage).
In terms of the office segment, and the credit and securitization apparatus behind it, and the inflated “valuations” all this is based on: There is no way back to the old normal. A shakeout has now commenced, and when the shakeout is over – this could be a slow-moving process – there will be a new era with an oversupply of office space and chronically low demand.
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