Maybe banks, instead of keeping the riskiest CRE loans, securitized them and sold the CMBS? Would be a hoot to find out over the next few years as this plays out.
By Wolf Richter for WOLF STREET.
So another big office landlord – another Commercial Real Estate fund by Canadian CRE giant Brookfield Corp – defaulted on another big floating-rate mortgage for a portfolio of office buildings.
And once again, it’s the holders of CMBS that are getting to deal with this mess, and not banks, maybe because the riskiest CRE loans with floating rates were securitized into CMBS, and banks hung on to the less risky CRE loans? We’ll find out over the next few years as this office-debt-unwind plays out.
Brookfield Corp. funds defaulted on a $161.4 million floating-rate mortgage for a group of office buildings, mostly in the Washington, DC, area.
The mortgage, which had been securitized into CMBS, was transferred to a special servicer, representing the holders of the CMBS. The servicer is working with “the borrower to execute a pre-negotiation agreement and to determine the path forward,” according to a filing on the CMBS, reported by Bloomberg.
Floating rate mortgages on CRE, particularly offices that are being vacated by one tenant after another, have turned into a deadly combination when short-term interest rates surged from near 0% a year ago, to nearly 5% this year.
On the Brookfield mortgage, monthly payments nearly tripled from just over $300,000 before the Fed’s rate hikes last year, to about $880,000 in April, according to the special servicer report.
And occupancy rates at the dozen office buildings in the portfolio dropped to 52% on average in 2022 – meaning nearly half of the space had no tenants and wasn’t generating any rent while mortgage payments were in the process of tripling – down from 79% in 2018, when the mortgage was issued, according to the special servicer report.
By comparison, the overall occupancy rate in Washington DC was 78% in Q1, and in Northern Virginia, the occupancy rate was 75%, both historic lows, according to Savills.
Special servicing rates of CMBS of office mortgages have soared. Among post-Financial Crisis-vintage CMBS, the special servicing rate shot up from 3.1% a year ago to 4.8% in March, according to Trepp, which tracks CMBS.
But that’s just the latest wrinkle for CMBS. The special servicing rates in March were much worse for retail (11.6%) and lodging (6.3%).
This default by a Brookfield fund follows the two defaults by Brookfield DTLA on mortgages and loans on two office towers in Downtown Los Angeles: The trophy tower at 555 West 5th Street defaulted on a $350 million mortgage, which had been securitized into CMBS, and two mezzanine loans, all of it totaling $465 million; and the tower at 777 South Figueroa Street, which defaulted on a mortgage and a mezzanine loan of $319 million.
The big office defaults that have been percolating around the US have largely hit CMBS holders and non-bank lenders. Lenders have recently taken huge losses when office towers were sold at foreclosure — and those lenders were largely CMBS holders.
It’s the riskiest loans with floating rates on buildings with occupancy issues that get weeded out first, such as older office towers. And that’s the wave of defaults we’re now seeing.
Of the overall CRE debt, only about 45% is held by banks, and the remaining 55% is held by investors, such as life insurers and pension funds, and non-bank lenders such as mortgage companies, mortgage REITs, or PE firms, or has been securitized into CMBS, CDOs, and CLOs, which are spread around global bond investors. About 21% of CRE has been securitized into government-backed Agency or GSE multifamily MBS (I discussed the banks’ share of CRE debt in detail here).
Free-money feeding frenzy among investors?
It would be a hoot to find out over the next few years that the chase for yield during the free-money era created such a feeding frenzy among investors of all kinds that they aggressively outcompeted banks by offering better terms on CRE loans.
And so they eagerly originated floating-rate mortgages on overvalued buildings because they figured that the Fed would hike rates soon, and that they would benefit from those rising short-term rates which would push up the floating rates and thereby push up the yield and income from the loan, and therefore protect the value of the loan.
And that makes sense, if they were counting on the Fed to hike by 200 basis points at the total max and then promptly pivot as it had done last time. And maybe they didn’t take the shift to work-from-home seriously, and maybe they expected office buildings to always remain at the center of the US economy, ensconced in an aura of a permanent office shortage. And so maybe they didn’t figure that rates would rise by 475 basis points, while office occupancy rates would plunge, turning into a toxic mix for borrowers, so that they would just default on the floating-rate loans to renegotiate the loans or walk from the properties?
And maybe banks were onto it, and instead of hanging on to those riskiest loans, they securitized them and sold the CMBS to investors? That would be a hoot to find out.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.