Distress looms over U.S. commercial real estate in 2021
The world could remember 2020 when the year “normal life” was torn apart by the coronavirus pandemic.
But for many U.S. commercial property owners, the big problem hasn’t even started.
“I think it’s going to be a two-headed monster,” said Pat Jackson, chairman and founder of Sabal Capital Partners in Irvine, Calif., Of the prospect for difficult buildings.
“Some assets will recover and do well. Obviously we are very optimistic about apartment buildings over the long term, ”said Jackson, a lender and billionaire investor in assets in the last recession. “On the other hand, there is much tribulation and it is coming.”
Jackson sees properties that have gone “off the runway” after almost a year of disruptions. And while the government scrambles to distribute vaccines, lockdowns in the US have increased again in the colder months as COVID-19 cases, hospitalizations and deaths have increased.
The coronavirus resurgence has raised fears that a V-shaped economic recovery may be out of reach, while also raising concerns that banking regulators, worried about potentially spiraling risks to the financial system, could take action against banks and others, who are exposed to the realization discount.
“The second surge in COVID didn’t help anyone,” said Lisa Pendergast, executive director of CRE Finance Council, a commercial real estate finance trading group.
Pendergast noted the 10.2% of loans from the nearly $ 600 billion commercial mortgage-backed securities (CMBS) market offered in the Special Servicing section in November. This category is often the first stop for borrowers looking for temporary or permanent debt relief.
This is below the high of 12.6% after the global financial crisis of 2008, which took about two years to reach. However, the volume of problem loans could increase slightly as the pandemic continues and more borrowers grapple with the consequences, including how the use of commercial buildings will ultimately change.
In a sign of the times, New York’s volatile commercial real estate industry recently made a proposal to convert around 1 million square feet of Manhattan office space to housing, the New York Times reported, in an attempt to avert a possible collapse in real estate prices.
Check out: Ho, ho – oh no! Troubled Manhattan retail property values are down 53%.
Large homeowners have also become a focal point, as the CMBS market, unlike home loans from banks and insurance companies, makes it fairly easy for Wall Street borrowers to move away from homes when problems arise.
“You can just return the keys,” Pendergast said of most CMBS financings.
A roadmap for need
For decades, the CMBS market has been an important corner of finance, packaging loans for hotels, offices, industrial centers, and other commercial real estate into bond deals and selling them to investors, including pension and bond funds.
While CMBS is not the largest source of commercial real estate finance, it does appeal to borrowers looking for debt on a no-recourse basis. If a property fails or lands underwater, a lender cannot avail of the operator’s other assets to make up for losses.
“Remember,” Pendergast said, “a lot of borrowers who secured an asset five, six or seven years ago have likely made a good return on their equity and made a profit.” Some will say, “Take my fortune.”
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That was seldom the case this year. According to Real Capital Analytics, distressed sales made up only about 1% of all commercial real estate sales in the past two quarters, although this is more likely.
Analysts, led by JP Morgan’s John Sim, compiled this potential CMBS loan and emergency schedule, including key dates for aid programs to expire after a flood of homeowners fell back in March when a national emergency was declared.
The liquidations should begin later this year
Properties to be observed
While CMBS borrowers may find it easier to get rid of their debt, high profile problems don’t often go quietly.
This is because bondholders receive monthly property-level performance reports that make it possible to track specific shopping malls, famous hotels, and even the demise of a historic building in Times Square that was funded by President Trump’s son-in-law in the months leading up to his inauguration.
Jared Kushner signed loans to 229 West 43rd Street, an 18-property building that housed the New York Times, in October 2016, before becoming an advisor to his father-in-law at the White House.
According to real estate data tracking platform CREDiQ, it is about $ 1.1 billion worth of real estate loans that are currently considered non-performing in Times Square. The most recent property appraisal has reduced the value by 80% to around USD 92.5 million.
“That was kind of an eye opener to see how much the value had fallen,” said CREDiQ co-founder Bill Petersen. However, he also believes the property’s problems may not necessarily reflect the value of other buildings in Times Square, given that it was losing major tenants before the pandemic.
Kushner Properties did not respond to a request for comment.
Record CRE debt
Ryan Severino, Chief Economist and Commercial Real Estate Company JLL JLL, -2.88%,
remains optimistic that parts of the market will snap back in the next 18 months if a successful COVID-19 vaccine can soon become widely available.
However, Severino also sees a tough battle for real estate that had to struggle before the COVID-19 success, or, in his words, for buildings that “after more than 10 years of economic expansion” found no support, including lower-quality shopping centers and office buildings in less desirable areas that have weakened since the last recession.
The total stakes have never been higher. Federal Reserve data shows that U.S. commercial property debt rose to an all-time high of $ 3.06 trillion in the third quarter, after a 10-year low of $ 2.2 trillion in 2012.
CRE debt hits record
St. Louis Fed data
Some real estate debts are easily repaid. Other owners will find debt or equity to weather the storm.
But the pandemic still likely means some properties will fetch fire sale prices. At least that is the hope among bargain hunters.
“It’s really good when everyone is looking for opportunities,” said Gayle Klein, a principal at McKool Smith law firm, which represents hedge funds, private equity and others in commercial and securities disputes. “Because my customers have money to spend.”