New York City
September 28, 2023 by Ciara Long,
The flood of distressed office situations that capital markets experts have been predicting for the last year has been slow to materialize, but a series of cracks in the dam this month show that a wave may be incoming.
The weeks since Labor Day have brought an influx of actions from keys being handed back to lenders to UCC foreclosures and credit downgrades that experts say represent a meaningful shift in the way struggling office buildings are being handled.
“We’re seeing small signs of distress,” said Marisha Clinton, a senior director of regional research in the Northeast for Savills. “There’s no question about that.”
Past predictions about an incoming wave of distress have been met with adamant denial from owners, but the frequency of distressed transactions this month alone is definitive, experts said.
“We’ve started to see some pockets of distress where there have been potential enforcement transactions,” said David Heller, executive vice president of Savills’ capital markets group. “Up until this point, there’s been very limited actions taken by lenders to enforce their positions and fore close on properties.”
The stress so far has been driven by maturity defaults, David Putro , head of CRE analytics at Morningstar Credit, told Bisnow by email. But he said term defaults, in which borrowers miss a monthly payment, are starting to appear.
“These term defaults are going to be an increasing concern as things play out,” he said, adding that tenant considerations over how much space they need in the era of remote work will likely increase the frequency of this type of default. “I certainly expect more term defaults moving forward.”
Last week, Shorenstein Properties defaulted on a $350M CMBS loan tied to 1407 Broadway, a 1.1M SF office property.Just a few avenues away, a joint venture between Meadow Partners and Somerset Partners handed 300 East 42ndSt., a 237K SF office property in Midtown Manhattan , back to lender Fortress Investment Group, The Real Deal reported.
In the same week, Moody’s downgraded a $1.7B office loan that had exposure to We Work, social media platform X and First Republic Bank. RXR also put a $240M non performing note on 61 Broadway up for sale after reaching maturity default on May 1, per The Real Deal. Those weren’t the only transactions indicative of distress this month.
Real estate investment trust Churchill Real Estate sold at a loss the 35K SF office property near Penn Station, which it paid $90M to develop, in a foreclosure sale earlier this month,
Crain’s New York Business reported.
Securities holding mortgages for both Cohen Brothers 359K SF 750Lexington Ave. office building and for Metropole Realty Advisors’ 90K SF681 Fifth Ave were downgraded by Fitch, Crain’s also reported.
In early September, a court-appointed receiver said that Thor Equities had abandoned the 13K SF Scribner Building, a Class-A, land marked office and retail property named “a jewel on Fifth Avenue” by the Municipal Art Society of New York.
Thor defaulted on a $105M loan on the building in 2020, per The Real Deal
“Walking away from assets losing money is not a good situation for anybody,” Putro said.
Even bigger names have also been affected since uncertainty over the office market’s future appeared.
Blackstone made headlines last March when it decided to hand the keys to 1740 Broadway, a 621K SF office tower,back to lenders. It lost two major tenants in 2019 and 2020, leaving the owner with sizable holes to fill in the property.
And earlier this month, the loan backed by the property hit the market after cycling through two special servicers.
The trajectory of 1740 Broadway is a good example of the timeline that distress can take to play out, said Greg Corbin, president of Northgate Real Estate Group, a firm that specializes in bankruptcy, loan sales, foreclosures,restructuring debt and workouts.
“We’re seeing delinquencies,” he said. “People are stopping their payments.But it’s a really long arc between someone not making a payment and something actionable like keys switching hands.”
A forbearance looks better than selling for a loss for owners and investors,Corbin said, but using judicial options to force ownership changes is still something that is likely to occur at a higher frequency over the coming months.
“I think there’s going to be a lot more UCC foreclosures,” he said, adding that UCC foreclosures are often also one of the faster ways to force ownership changes. “They can usually get that done in about 60 days.”
But while workarounds were still possible, Blackstone’s decision was likely a strategic play, JLL New York City Director of Research Andrew Lim said.And that option isn’t necessarily on the table for everyone.
“For smaller owners whose portfolios maybe are not as varied or have less wiggle room in general, those are more in the realm of what we’re perhaps talking about in terms of distress,” he told Bisnow.
“We’re seeing significant reductions in value for all investors. They’re just being priced lower when it’s coming up for refinancing or you’re having valuations of assets.”
Falling rents in Manhattan’s office blocks are part of the picture, Savills’ Clinton said. As rents drop, so do property values, leaving owners who may need to refinance over the next few years in a tight spot, especially with higher interest rates increasing the cost of borrowing.
“There’s some private equity investors that have raised funds to take advantage of distress that they’re seeing in the market, as they, too, believe that the worst is yet to come,” she said. “If there is a building where there’s large amounts of lease rollover and high vacancy, then in those situations, it becomes nearly impossible and very risky for anything to want to extend the maturity or even do a refinance.
There will be more distress transactions happening when interest rates go down and raising capital gets easier, but opportunistic investors feel that the market isn’t quite ripe yet, Lim said. In the meantime, NYC’s office market will likely see more forced sales through mechanisms like UCC foreclosures.
“I expect to see a continued deterioration,” said Shlomo Chopp, a managing partner at NYC-based investor Terra Strategies, adding that he expects the market will soon relinquish hopes that the
Federal Reserve will decrease interest rates in the near term. “That has significant ripple effects because a bond holder behind the CMBS trust — that may not be willing to accept the loss because they think that the rates are going to change — will now take a loss.”
NYC’s Class-B and C offices started to feel the initial effects of a repricing wave this spring, prompting sales like 850 Third Ave., an office tower that the Chetrit Group sold for $266M in February after buying it for $422M in 2019.
But overall, pricing discovery and valuations haven’t reset significantly enough for it to be seen as a correction, JLL’s Lim said.
“We’re having this conversation to ask, have we seen the bottom? Is the bottom coming close?” he said. “I think the sense is it’s not quite there yet.There’s still some things that need to sort themselves out.”
CORRECTION, OCT, 19, 10:55 A.M. ET:
A previous version of this article misstated investor sentiment on forbearance agreements. This article has been updated.