The loans were securitized into CMBS in 2014. From hype to heck in 7 years. Other markets with office busts have something to stew over.
By Wolf Richter for WOLF STREET.
We’re now seeing some of the results of the Houston office bust percolate through Commercial Mortgage Backed Securities (CMBS). Houston’s office market got hit by a triple-whammy.
First there was an office construction boom riding on high oil prices. Then there was the collapse of high oil prices – WTI plunged from over $100 a barrel in mid-2014 to about $25 a barrel in 2016 – that sent a slew of oil-and-gas companies into bankruptcy and caused an industry-wide wave of layoffs, including of office workers, cost cutting, and debt restructuring. Then came working from home, which reduced the need for office space further.
By Q4 2021, 33% of the total Class A office space was on the market for lease, the worst in the US. In the Energy Corridor, 35% of all office space was on the market for lease.
As the latest and greatest office trophy towers were completed and came on the market, and with so much fancy space available, oil companies, law firms, and other businesses began to upgrade their digs, moving from older office towers to the latest and greatest, and the older office towers started emptying out, and then started defaulting on their loans that had been securitized a few years earlier into CMBS and sold to investors.
So what are older office towers like this worth when they’re finally sold? Not much. And how much are lenders and investors losing on them? Huge amounts.
This is an example of such an office building that was just sold, and the numbers are in. Three Westlake Park, a 420,000 square-foot Class A office tower in Houston’s Energy Corridor, completed in 1983 and renovated in 2005, had gone into default and was taken over by its lenders. It has now been liquidated, and the numbers are in, and they’re horrible. This is the building:
Its sister tower on the same campus, the 450,000 square foot Two Westlake Park, had already defaulted on a $87.5 million loan in 2018.
The loan, which had been securitized in 2014 by Wells Fargo into CMBS (WFRBS 2014-C24), was liquidated in mid-2020 in a foreclosure transaction, where the collateral sold for $18 million. Trepp, which tracks CMBS, reported at the time that after $2.2 million in foreclosure fees and expenses, lenders wrote off $71.6 million of the $87.5 million loan, for a loss severity of 81.9%.
OK, so now the Three Westlake Park was liquidated, and the numbers are even more horrible.
The outstanding mortgage loan balance on Three Westlake Park amounted to $76.3 million, according to Trepp. Back in 2014, when the mortgage was securitized by Goldman Sachs into CMBS (it made up 10.4% of GSMS 2014-GC20) and sold to investors, the tower was occupied by ConocoPhillips and BP. But BP moved out in 2015, amid job cuts. And Conoco Phillips vacated in 2019 when the lease expired. Since then, the building has been vacant.
In 2014, on the verge of the collapse of the price of crude oil and the downturn of the Houston office market, the $76.3 million loan for Three Westlake Park was securitized into CMBS. For the purpose of selling the CMBS to investors, the collateral was “valued” at $121.1 million. Investors even in the lower classes of the CMBS rested assured that they would have little risk of loss, protected as they thought they were by the high “value” of the collateral.
This has been a slow-moving train wreck. In 2017, with the oil bust in full swing and older office towers starting to empty out, Kroll Bond Rating Agency estimated that lenders would take a $27 million loss on the collateral.
In October 2018, given the departure of the tenants, the loan was sent to the special servicer, which commissioned a series of appraisals. The first appraisal came in 2019, which slashed the “value” of the collateral to $41 million. The second appraisal in 2020 lowered the value to $38 million; and the third appraisal, in 2021, slashed to collateral value to $25.2 million.
The tower has now been sold for $20.6 million, after having been “valued” at $121.1 million in 2014 for the purpose of selling the CMBS to investors. After liquidation expenses of $11.7 million, lenders got just $9.2 million, forcing them to write off $67.4 million of the $76.3 million loan, for a loss ratio of 88.3%.
The Houston office market is in a particularly tough spot. And as with Two Westlake Park and Three Westlake Park, the issues take years to finally get resolved with huge losses for the lenders.
Other cities too are now facing their own office busts, with huge amounts of office space on the market for lease, and few takers, amid massively inflated office rents.
The Number 2 hardest-hit office market, behind Houston, is San Francisco, which just a few years ago was the hottest office market in the US where the “office shortage” made headlines. Then the shortage turned to glut. By Q4 2021, 26% of the total office space in San Francisco was on the market for lease. In Manhattan 19% of the office space was on the market for lease. It’s the older towers that empty out, as a flight to quality sets in when the lease expires, allowing the fancy new towers to find tenants eventually, but not at the rents they’d envisioned.
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