Whoever buys the defaulted loan gets the tower. So far, investors and specialized lenders have been on the hook, not commercial banks.
By Wolf Richter for WOLF STREET.
The market for office towers is starting to thaw just a tiny bit, and some sales have now occurred or are on the horizon, with massive markdowns that serve as benchmarks for future deals. Until these sales occur, no one really knows what older office towers are worth in the new era of working from home and vacant office towers.
In Manhattan, sales of office buildings have collapsed from $5 billion in Q1 2022 to just $489 million in Q1 2023, the lowest sales since 2009, according to MSCI, cited by the Wall Street Journal.
Some of the future sales come with a twist: The defaulted loans get sold, not the properties, and the new holder of the loan can then take possession of the building and do something different with it. And it’s the big landlords that are sending the jingle mail to the lenders.
The lenders that are getting caught by the defaults of big office towers and multi-family properties that have come to my attention and that I have discussed so far were investors, primarily holders of Commercial Mortgage-Backed Securities (CMBS) and specialized CRE lenders – not US commercial banks; their turn will eventually come.
50% off the 2016 valuation. RXR, which describes itself as “one of the top landlords in New York City” with 83 office and residential properties under management, defaulted on the $240 million loan on its 33-story 1914 office tower at 61 Broadway, in the Financial District. It will let the lender have the property through a deed-in-lieu-of-foreclosure in July.
RXR had purchased the property in 2014 for $330 million and invested some money to update it. RXR CEO Scott Rechler told The Real Deal that the firm had already gotten its money out: in 2016, at the peak of the Chinese overseas investment binge, RXR had sold a 49% stake of the tower to China Orient Asset Management at a valuation of $440 million.
RXR and China Orient then refinanced the tower in 2019 with $325 million in debt, including some junior debt and this now defaulted $240 million mortgage from a syndicate led by Aareal Capital Corporation, a subsidiary of German property lender and structured finance specialist Aereal Bank. The mortgage is non-recourse, and the lenders can only get the collateral.
Aareal is now trying to sell the mortgage and has hired commercial real-estate firm JLL to market it. Whoever buys the loan will get the tower. According to market participants cited by the WSJ, the tower may sell at half the price of its $440 million valuation in 2016.
38% off the 2020 refinance valuation. Or 45% off if renovation costs are included? Silverstein Properties has agreed to sell the 20-story 1958 tower at 529 Fifth Avenue for $105 million, to Empire Capital Holdings. The price is down 38% from the $171 million at which it refinanced the tower in 2020. Silverstein started on a $20 million renovation project of the tower. If those costs are included, the discount would amount to 45%. Silverstein has owned the tower since 1978.
33% off 2018 sales price, or 41% off 2020 asking price. PE firm Blackstone sold its 49% stake in One Liberty Plaza at 165 Broadway back to PE firm Brookfield at a price that values the tower at $1 billion, after having bought the stake from Brookfield in 2018 at a valuation of $1.5 billion. Brookfield now owns the whole tower again. The tower dates from the 1970s. In early 2020, Brookfield and Blackstone were trying to sell the tower for $1.6 to $1.7 billion.
While at it… Both PE firms have serially defaulted on loans backed by office CRE and have already dumped or are trying to dump office towers.
Blackstone’s list includes two office towers in Southern California which it dumped for a 36% loss. Last year, Blackstone walked away from the 26-story, 1950s tower at 1740 Broadway in Midtown Manhattan, letting the lenders – CMBS holders – to deal with it and take the remaining loss.
Blackstone defaulted on €531 million ($570 million) in CMBS backed by a portfolio of office properties and retail stores in Finland. And it is set to default on a $270 million variable-rate loan backed by 11 apartment buildings in Manhattan. The loan, which was securitized into CMBS, comes due in August and has been sent to special servicing. All these loans are non-recourse – jingle mail material.
Brookfield defaulted on a $161 million floating-rate mortgage for a group of office buildings, mostly in the Washington, DC, area. The loan had been securitized into CMBS. It also defaulted on $784 million of debt backed by two Los Angeles office towers, the Gas Company Tower and the 777 Tower. And the loan backed by another one of its towers in Los Angeles was sent to a special servicer.
The Manhattan haircuts appear to be less severe than the San Francisco haircuts. San Francisco’s office market is in far worse shape than Manhattan, with about one-third of the total office space on the market for lease. But now there was finally the first sale of the new era that broke the ice and became the first benchmark deal: Union Bank sold its 300,000-square-foot headquarters tower for $60 million to $67 million, after having originally listed if at $250 million in 2020, amounting to a 75% haircut from the 2020 listing price.
And yet, office construction continues. In Manhattan, 13 million square feet of new construction is scheduled to be delivered by the end of 2023, including Brookfield’s 2-million square-foot 935-foot-tall Two Manhattan West and Vornado’s 1.6 million square-foot PENN 2 (new construction and major renovation of existing buildings) at Penn Station and Madison Square Garden.
And the flight to quality sees to it that these trophy towers will attract tenants that are bailing out of their old digs for top-notch and often smaller office space with the latest and greatest amenities. This flight to quality is helping to empty out and doom the old towers, while the newest towers fare better.
These major construction projects that will be delivered over the next few years were planned years in advance, when the sudden structural change in the office market wasn’t even on the horizon. So there is this flow of new office towers in the pipeline, and they will keep coming for years, and they will keep pulling tenants out of older towers.
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The solution is conversion to residential once they are cheap enough for the cost to make sense.
Not all that many office buildings can be converted to residential in a cost-effective way. For those buildings, it will be cheaper to tear them down and build a modern residential building from scratch. The property value of those office buildings may be land value or less.
So you are saying they are worth the land minus the cost of demolition?
I think so.
Land value really depend on the location!
Yes. Land value, such as it is, minus demolition costs, minus the NY land taxes for such a period of time until rental income starts coming in. Not difficult to calculate. One may need a red pen for the bottom line, though.
Less than land value is a fun concept. The downtown Austin condo building that I am moving out of was constructed from reinforced concrete in the 1940s–built to last. The buyers still haven’t figured out how they are going to tear it down…
There is one primary reason that office towers have corrected so much but house prices haven’t.
No, it’s not work from home, because there are many empty houses as well.
It’s that investors that are buying office towers are smart.
Well, not so smart in those cases where their assets are worth half of what they were when they purchased or refinanced.
They will make it up in volumn!
The borrowers for office towers are also wiser. The take non-recourse mortgage and stop servicing loan as soon as they expect tower to go under water.
So it’s the bagholders problem and it’s not the taxpayers for CMBS.
See how removing taxpayers from equation fixes all problems.
“And it is set to default on a $270 million variable-rate loan backed by 11 apartment buildings in Manhattan. The loan, which was securitized into CMBS, comes due in August and has been sent to special servicing”
Interesting. Obviously we would need to examine the details of these properties such as the financing structure, whether a substantial number of renters are really in default, etc.
But I would question how much real demand exists for residential conversions in NYC office areas. Why live in a 1970s era NYC glass box if you are working from home?
Well, one reason is that somehow NYC rents are in the $3000 range for 1 bedroom…a new converted glass box might ask $4000.
It is all rather idiotic (the core financial jobs that drive the madness are really not all *that* numerous…and can be done essentially anywhere. It like crawling to work on your knees in a feudal estate. Goofy and getting well past its sell-by date).
Wolf, I am surprised that the commercial real estate crash has happened so quickly. Many commercial buildings have medium term leases (3-7 years) with a few years left with tenants on the hook. It appears that the transactions you described were overpriced and underleased when Covid arrived with mostly short term leases that ended since March 2020. Since many subtenants are still paying something for another year or two, the bad news for commercial real estate hasn’t really arrived yet. For GAAP accounting, publicly traded companies have to do an impairment analysis for empty leased space. I would expect that impairment losses have become common starting in 2022. The financial news would have to be reported in 10-Ks or 10-Qs, so it’s public news. I am not sure what the source of your info is since companies don’t like to report losses publicly if such info can be be hidden. thx,
Yes, it surprised a lot of people – maybe everyone. These older office towers have huge vacancy rates, and they cannot be filled. Tenants move to smaller offices in new buildings. So the revenues don’t cover the mortgage payments. And when the mortgage is due, you get the maturity default. Some of this has been going on for a while. But now the hope is gone. Everyone knows it’s just going to get worse. There is no hope of ever filling up those old office buildings at rents that are high enough to allow the landlord to pay for a 7% variable-rate mortgage that was 3% two years ago. The whole entire math has fallen apart under the two big movements of working from home and higher interest rates that have converged on the office glut.
Fascinating. Real estate moves slowly. Interesting that these companies were trying to sell in 2020 and 3 years later toss the keys. That’s a long time to watch your investment die.
Who are these investors losing 30-75% of their principal investment? Are Blackstone, R&R, Brookfield etc comprised of wealthy private investors? I realize this is one small sector of investment, but that seems like a lot of wealth transfer (loss).
most of these ‘investments’ get refied within couple years of purchase
thereby allowing ‘investor’ to pull out their down payments plus usually even more
then they just get their annual management grift until it’s time to jingle mail
Your pension fund banks investors
And ultimately, once again, the US Taxpayers when these pension funds are bailed out. So, everyone in the chain collects big fees and all of us are left holding the bag.
Moral Hazard is real and pervasive.
Three thoughts. 1- It may be too expensive too convert the buildings into 2 br apartments, but they certainly can be converted into luxury 2 br condos with massive living space. If you got 4 condos a floor, $5 million a condo, you could generate $600 million in a 30 story building. Half that spent on conversions would still be roi positive in this type of situation. Or $2.5m condos with less money spent on conversions. That much living space has to be worth it to some people who want indoor personal space in the city.
2- Aren’t there businesses that require lots of square footage? Offices cram people together and can easily get rid of space. Aren’t there computer servers and music studios and autonomous vehicle designers that just need space?
NY Times had a great article on what it takes to convert a commercial building to residential.
They came up with a cost of about $500/sqft to convert, depending on the building.
Arnold,
Thanks so much for this! That is a very interesting number. RE is REALLY ( groan ) expensive in NYC.
A suburban condo with a great location here in the western ‘burbs of Chicago – already built – is only is only about $330/SqFt.
Of it doesn’t have the wonderful homeless and crime situations that make NYC so a desirable place to live.
And even that $330 psf new build “cost” in Chi is the product of 20 years of ZIRP hallucination/goosing, now evaporated.
Unless builders want to cease business entirely, they are going to have to “miraculously” find some way to cut 35%+ off their “costs”.
ZIRP gave those same builders 20 years of windfalls and foolish buyers 20 years of a “stoned sleep”. Now, the rough beast of reality has come round at last…
This seems like a huge oversight for the Federal Reserve. While the Federal Reserve can only buy Federal agency (taxpayer) backed securities, certainly there must be some way to manipulate the original bank so that this worthless office glut is security for a bank liquidity injection using the myriad of wealth transfer tools.
Give it a few months Gary.
It isn’t like all the Fed’s corruption just takes care of itself.
Will small and mid sized banks unleash banking crisis 2.0, and if so, how will the fed respond? Will the Fed buy a tiny amount regional banking ETFs, like happened back in 2020 when they bought some Apple bonds via the LQD corporate bond ETF, in order to save the world of mega tech investors?
Will the Fed cave and drop interest rates prematurely, regardless of inflation levels, before the approximately $1.5 Trillion of CRE loans come due by 2025?
The question isn’t “IF” the Fed is going to drop interest rates in 2024, but how low will they go before inflation heats back up and forces rates higher???
So far, the banks have been spared. The losses here are taken by investors, both on the equity side and the debt side.
This is a pattern I have now seen every time. It makes me wonder if the banks cherry-picked what CRE debt they kept on their balance sheet, and what they securitized into CMBS and sold off. Wouldn’t surprise me if we find out that the highest-risk and most-overpriced stuff ended up in CMBS and CLOs and then in some bond fund, and then in some 401k.
Gee, I hope I am not the only one laughing. Employers have always wondered why I wanted nothing to do with their retirement plan.
Very ugly…..and seems has a way to go yet. I’m always amazed to see price drops like those in S.F. comm.realty……staggering…and must have a wave effect…guess affects pensions, funds etc that invest in CMBS…..how many pensions bought those for a bit extra income the last few years ? Probably a small part of many pensions/funds, and, ugh, a larger part of a few.
I read that Manhattan high rises are sinking at the rate of several millimeters (~1 or 2) per year depending upon the resistance of the land upon which they’re built. Same kind of thing in San Francisco. I recall Embarcadero Center buildings swaying perceptibly. Wind? Or sand? Or some combination.
1) The math is simple : from WFH that destroyed the old –> to no WFH, in the next recession, that will vacant the new.
2) mgr are begging for a trigger to start laying off expensive, arrogant, unproductive employees in environment of inflation, high o/h cost, costly dual WFH/work from office and higher interest rates for commercial RE. The rest is bookkeeping.
3) Single family homes might join commercial buildings club, no matter how low was mortgage rate.
4) The AI vertical is a smoke screen. The McC $4T is a dry powder.
5) In Manhattan old commercial buildings are dying not because of WFH,
but because old industries are dying, the are gone !
Investors should reconsider the wisdom of lending without recourse.
Its like a big cycle. Many of the original skyscrapers in Manhattan were built for insurance companies. This was one of the first industries that needed to put together large numbers of people in close proximity, near transit lines to do paperwork. The insurance industry ( in all forms) is now at the beginning of a collapse cycle ( see State Farm pulling out of property markets in CA). The conditions that made life, fire, etc insurance possible are now disappearing. Increasing lifespans, stable currency, low inflation, predictable weather, efficient judicial system , public police and fire protection are now going the way of the dodo. So as the insurance industry dies it will usher out the era of the tall office building in urban centers, just as it ushered it in.
That’s not accurate at all.
Newspapers, hotels, and apartments were the original purposes of sky scrapers in Manhattan.
Times Square is named for the NY Times after all.
Seneca/Arnold – merge the business timelines and you’re both right (…after all, ‘Rome wasn’t built in a day’ and didn’t crumble overnight…).
may we all find a better day.
Technology may have something to do with changes in the insurance industy too. Today there is less ned to put together large numbers of people in close proximity, near transit lines to do paperwork. The “paperwork” is electronic and broadband connection negates the need to have all people close to each other.
The insurance industry is moving all their jobs to claim centers in India and elsewhere. There is no need for the high rise insurance buildings. A dude I talked to at my favorite fish counter told me his most recent claim with State Farm was handled by a claims adjuster in India. He said the claim was handled very poorly. They guy didn’t know squat and was reading from “talking points”. Told him to go to a doctor and fax the receipts if he had any injuries. This is after he told the guy he did not get injured in the accident.
From a different (somewhat longer) perspective, these big cities are totally unsustainable.
Just got back from a short trip to Chicago downtown. Looking at the age of many buildings, condition of “El” steel supporting the train tracks, thinking about the massive amount of underground utilties. And tons of ground level retail space for lease in the heart of downtown. Everywhere!
Friends living in smallish condo in the city paying $12K/year in property taxes. That’s low, I know, compared to many large cities, but smallish towns and cities have nowhere near this tax burden.
Getting back to aging buildings and infrastructure, imagine what is involved with early 1900’s buidlings, inspections, fire escapes, repairs, etc. Yes they were solid built back then, but we’re talking 100+ years.
The reversal wave out of big cities is just beginning. Office towers are one aspect; high property taxes, violent crime/homelessness on the streets, are other factors coming to play.
I think Wolf’s insight into what is going on with office tower CRE sheds some very powerful insight into what may be the leading edge of a very big wave.
Crime rate in the Southern States is much higher ( although our northern most state, Alaska, leads the pack for violent crime ).
You compared his comment about cities to entire states which makes no sense. I’m pretty sure Chicago, which had 697 murders in 2022 had a higher crime rate per capita than, say, Alabama. Birmingham, the largest city in Alabama had 153 murders in 2022 and the entire state has about 5 million people.
Re: Chicago, to quote BTO, “You ain’t seen nothing yet.” The wealthy were already, as in many big cities, moving out to avoid high taxes (and so many other things!) If the new mayor is able to enact even half of his proposed new taxes –and with Chicago politics it WILL happen– there will be a tidal wave.
They just increased my valuation 45k from 255-307 k in Omaha ne I’m leaving had enough
Where are you headed to? It’s not much better elsewhere.
Start looking at numbers 80 thru 100 on the monthly Zumper rent survey. Some cold locales…but Omaha ain’t exactly Miami to begin with.
Rural Iowa really affordable
Flea – convince enough people of that and watch it magically vanish…
may we all find a better day.
Sorry Flea but in my small town county in Texas just boosted my prop tax appraisal value on 20 year old home from 600k to 960k . Prop tax increase capped at 10 percent annual so will take a few years to hit the peak rate. Sorry I’m ahead of the race but don’t come to Texas for lower taxes .
Unlike most homeowers (spelled correctly) CRE speculators are sophisticated speculators and have nobody to blame but for themselves just like the Japanese in Los Angeles in the late 1980s.
I read in the news that Elon Musk is now predicting housing prices are going to fall next, just as they have in commercial real estate. This particular article didn’t explain why he thought this or how they’re interrelated. Can any commenters here explain?
Well, musk tweeted it so noone but musk can explain what he’s actually thinking. Maybe he just sees the reality that values have dropped and sales volume is still way down, which means buyers are at a lower price point still, home prices have to come down in order to sell.
Seen on internet ,homes being built pre fab by musk 15k out the door
Elon’s track record on predictions is not anything he brags about.
90% of everything in RE comes down to interest rates.
DC has manipulated interest rates deeply downward for 20 years (see money printing, see inflation).
Now that the stoner orgy is (temporarily) over, reality is reintroduced (and then some) and doubled rates means halved prices.
Indians with a hand full of beads to repurchase Manhattan
Just an idea…..in 29 the stock market was one of the causes of the depression.
If all these building across America get revalued……is this a trigger?
Even in a city of 150,000 people there are buildings that used to hold business people and now those folks are working from home……
IBM just announced that over the next 5 years 8000 people will get laid off in HR and replaced by AI. I suppose the machines will need some space but I doubt they will need all the space of 8000 people…..and they certainly don’t eat lunch, drop off cleaning, etc etc.
For those of you that might make it another 30 years it’s going to interesting….or scary.
Real estate might be about to trigger some big changes.
So, AI in HR hires a worker based on an AI-generated resume, submitted by a 10-year old.
Then, IBM gets sued by an AI lawyer for violating child labor laws. LOL
BTW, whatever happened to the self-driving car projects? That was the AI you could have taken to the bank;-))
The robo taxis without driver are starting to circulate in small numbers in San Francisco. They have caused some hiccups, some of them funny because no human would be this stupid, but they’re better than human drivers in other aspects. I can’t wait to get on the list to take one of those robo taxis.
Wolf,
What is meant by “special servicing”?
A “servicer” (sometimes a bank like Wells Fargo) takes care of the administrative parts of the CMBS, such as processing the interest payments to the CMBS holders.
A “special servicer” enters the stage when there are concerns about a default of the loan. At that point the “servicer” will send the loan to a “special servicer” who represents the interests of the CMBS holders and negotiates with the borrower to resolve the situation. If the default cannot be cured, the “special servicer” deals with the situation all the way through a foreclosure sale, and then distributes the proceeds minus fees to the CMBS holders. All this is spelled out in the securitization documents of the CMBS.
When a loan is sent to “special servicing,” it means there is trouble.
“A “servicer” (sometimes a bank like Wells Fargo) takes care of the administrative parts of the CMBS, such as processing the interest payments to the CMBS holders.”
When you have to depend on Wells Fargo to take care of your administrative tasks you are essentially doing what amounts to putting Count Dracula in charge of your blood bank.
S&P Global stated they think that the Housing selloff that started in 2022 may be at a bottom but there are still some headwinds. Charts still look like a bubble though?
“Two months of increasing prices do not a definitive recovery make, but March’s results suggest that the decline in home prices that began in June 2022 may have come to an end. That said, the challenges posed by current mortgage rates and the continuing possibility of economic weakness are likely to remain a headwind for housing prices for at least the next several months.”
I think a lot of people wish the slump was over. But it is not. Most likely, after this weak spring season, which should be the strongest, more weak seasons will follow. With these interest rates, which will remain for a long time, the decline will probably continue for years. As was the case with the previous bubble of 2007
Here’s the thing, and I’m sure this will get covered in a future article, it’s sales volumes which have collapsed. Prices could take years to form a trough, similar to 08.
There are so few houses for sale that is almost impossible to get accurate Comps to do a market analysis appraisal. Values are all over the place. Lenders are going to clamp down on lending because of the increased risk triggering a credit crunch.
Observations: In NYC, developers…develop. (Vapid thoughtless is endemic to US development, as waterless housing in the Southwest also illustrates.) Thus they don’t adapt, but rather just do more of the same, because as pointed out here, in NY, tenants willing and able to pay will always move to the newest space. What’s left behind is mostly a mountain of dilapidated purpose-built junk that usually cannot be adapted for reuse. Until now the inherent foolishness of this model (for the city) has been obscured by redevelopment/movement by industries (e.g. downtown to midtown) but that is now at an end.
That said, I think the predictions of the doom of major cities are incorrect. The US will have neither the capital, the resources, or the willingness/ability to continue to fund single-family suburban sprawl, which itself is a model constructed upon a post WW II dominance undergirded by unlimited fossil fuel resources. (The collapse of the suburban mall notion within a generation of its blossom is a forerunner of what’s to come, and everyone isn’t going to move to Texas.) In other words it will simply become too expensive to live in exurbs, except in prefabricated units. And this leaves aside the costs of maintaining a highway and telecommunications network that can never recoup its costs. The US (excepting, say, the top 20%) will shrink in land use because it must. The upshot of all of this will be repetitive convulsions in the securitized property segment of the economy until someone develops a forward-thinking approach to RE development replacing our current backward-disposable model.
1) Bloomberg Commodity Index deflated. Nutrien (NTR) too.
2) Manhattan street level stores, a major source of income to owners of small old buildings, are dying for decades. In 2009/12 the banks plugged in and converted few to banks branches, but the downtrend cont. relentlessly.
Many blocks of front street stores are shudders, gone. C/S never talked about them. The positively biased C/S is down because pairs like : bought in 1995/ sold in 2023 are diminishing.
3) Manhattan dying businesses didn’t move to fancy buildings with a gym,
a swimming pool and restaurants with top view, Those old industries are in the hospice bed.
4)
5) NDX was rejected by BB #5 : July 7/8 2021, 14,891.19/14,551.76.
6) SPX 1M : Apr 2023 high was : 4,170.06. Today close , at 11:48 ==> 4,170.07. Life is good.
commodities are still in a downtrend for 2022. Most everything except cattle and gold
Downtrend that started in mid 2022.
Ru 82 food and silver
Interested in insights on how the commercial real estate workout will impact life insurance companies, particularly the big mutual life insurance companies–Northwestern, MassMutual, NY Life, and Guardian.
Well, one reason is that somehow NYC rents are in the $3000 range for 1 bedroom…a new converted glass box might ask $4000.
It is all rather idiotic (the core financial jobs that drive the madness are really not all *that* numerous…and can be done essentially anywhere. It like crawling to work on your knees in a feudal estate. Goofy and getting well past its sell-by date).
“ Silverstein has owned the tower since 1978.” Why do they still have a loan on this tower after almost 5 decades? They just kept rolling the existing loan into new loans?
Everyone refinanced the old buildings based on new valuations when the old loans come due — that’s how they drew cash out.
Refis are an essential part of the CRE business model and a classic example of how low rates create high valuations that support big refi proceeds that are distributed to investors that then circulate in the real economy. Put the process in reverse and valuations shrink and money disappears even though the jingle mailers may have actually done very well financially over time. Are the eventual bag holders sufficiently important politically to get a bailout? We’ll probably find out in a year or so.
Commercial real estate is down 33% – 50%
Residential real estate is up 33% – 50%
There’s no bubble!
Monday Properties is at risk of losing 7 high-rise office buildings in Rosslyn, Va, across the river from DC, after it missed a payment on a piece of an $841M loan, which matures in less than 2 weeks.