News
Losses pile up in prime bonds backed by commercial real estate debt
(Bloomberg) — For the first time since the financial crisis, investors in high-grade bonds backed by commercial real estate debt are being hit with losses.
Bloomberg’s Most Read
Buyers of the AAA portion of a $308 million note secured by the mortgage on the 1740 Broadway building in midtown Manhattan recouped less than three-quarters of their original investment earlier this month after the loan was sold at a large discount. It is the first loss of its kind in the post-crisis era, according to Barclays Plc. All five groups of lower-rated lenders were eliminated.
Market watchers say the fact that the pain is hitting top holders, with crushing safeguards put in place to ensure their full repayment, is a testament to how deeply troubled US commercial real estate markets have become.
Securities backed by single mortgages and tied to older office buildings dominated by an anchor tenant — like 1740 Broadway — are especially vulnerable, they say. Some analysts are already predicting further losses as more loans are sold for a fraction of their previous value.
“Now that we’ve seen the first commercial mortgage-backed securities take a hit, other AAA securities are sure to suffer losses,” said Lea Overby, CMBS strategist at Barclays. “These losses could be a sign that the commercial real estate market is starting to bottom out.”
With about $700 billion in non-agency CMBS outstanding and another $3 billion in commercial mortgages on bank balance sheets, even a modest increase in losses could weigh on the financial system for years.
To be clear, no one foresees a repeat of 2008, when bad mortgages, particularly residential ones, nearly brought down the financial system.
However, the risk is not limited to just a handful of underperforming buildings.
The share of delinquent office loans grouped together in a common type of commercial mortgage-backed security reached 6.4% in April, the highest since June 2018, according to a Moody’s Ratings report this month.
More than that, about $52 billion, or 31%, of all office loans in commercial mortgage bonds were in distress in March, according to KBRA Analytics, up from 16% a year ago. The assessment includes both single-asset single borrower and so-called conduit CMBS, where mortgages are bundled. Some cities face more stress than others, with 75% of CMBS office loans in Chicago and 65% in Denver at risk, according to the company.
The story continues
“Values have fallen due to a combination of rising interest rates, which means increased investment, as well as decreased cash flow,” said Harold Bordwin, principal at Keen-Summit Capital Partners, which specializes in renegotiating distressed properties. “The consequence is that capital will suffer significant losses and secured debt holders will have their investment harmed.
The 1740 Broadway Building, formerly the Mutual of New York or MONY building, sits south of Columbus Circle between 55th and 56th Streets. Built in 1950, the letters formerly atop the building inspired the title of the 1968 hit “Mony Mony” by Tommy James and the Shondells.
It was purchased for $605 million by Blackstone Inc. in 2014. To help finance the deal, the company took out a $308 million mortgage, which was packaged into a CMBS and acquired by companies including Travelers Cos., Endurance American Insurance Co. others.
In 2021, L Brands, the former parent company of Victoria’s Secret and Bath & Body Works that occupied 77% of the property’s leased space, said it would exit the tower. Although Blackstone spent tens of millions of dollars to modernize the building, weak demand for office space has made it difficult to find new tenants. With no one paying rent, Blackstone abandoned the property in 2022, defaulting on the loan.
A few weeks ago, the special mortgage servicer and Blackstone agreed to sell the building to Yellowstone Real Estate for about $186 million, according to people familiar with the matter. The deal resulted in the CMBS being repaid. But with additional losses from fees and advances, only $117 million remained for bondholders. Investors in $151 million of lower-rated debt were wiped out, while those holding $158 million of debt originally rated AAA suffered a 26% loss.
“This deal was a perfect storm for an office building that relies on a single tenant for most of its rent,” John Kerschner, head of U.S. securitized products at Janus Henderson, said in an interview. “We will see more office-related titles, but this will take some time. Office leases and mortgages are very old.”
In an email response to questions, a Blackstone spokesperson said the company “discarded this property nearly three years ago. Less than 2% of our owned portfolio is made up of traditional offices in the US. This is not a new development and is a rare example in our nearly $600 billion portfolio.”
A Yellowstone representative did not respond to a request for comment.
Some industry observers say CMBS investors should expect more losses on bonds originally rated AAA in the coming months.
Barclays strategists warned in a recent report that top holders of at least four commercial mortgage-backed securities linked to shopping centers, including the former Westfield San Francisco and the Palisades Center shopping center north of New York, are likely to be hit. Office CMBS is increasingly on their radar, they wrote.
“As we are only in the early stages of office price discovery, we expect this list to expand to include multiple office deals,” Overby and Anuj Jain of Barclays said in the report.
They particularly flagged developments at 600 California St. in San Francisco, owned in part by a WeWork affiliate, and at River North Point in Chicago, owned by Blackstone. There is about $60 billion in office CMBS backed by single mortgages, according to Barclays estimates.
“Given the challenges facing the property, we have effectively canceled it in 2022,” a Blackstone spokesperson said in an email. A WeWork representative declined to comment.
Read more: Massive office tower losses reveal hidden risks around the world
In Chicago’s north suburbs, an office loan held by private equity giant Ares recently sold for just 12% of its original price. This debt has been bundled into a vehicle called a collateralized commercial real estate loan obligation, which in turn is facing unprecedented stress.
“It is very rare for AAAs to be reached, which is a more idiosyncratic case with high concentration in a single office loan,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “One must be extremely cautious as the value of office buildings is less transparent due to a lack of transactions, as are the securities linked to them.”
–With assistance from Scott Carpenter.
Bloomberg Businessweek Most Read
©2024 Bloomberg LP