Loan Modifications More Than Doubled Last Year

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The move for lenders to find ways to avoid action on troubled CRE loans has been called “extend and pretend,” though “delay and pray” might be even more apt.

While an institution can avoid significant and final decisions, it can put off the day when it takes a hit to its balance sheet, hoping that find another solution in the meantime. Who wants to take possession of a property along with the responsibility of disposing of it?

But how much of this activity has been going on and how long could it be sustained? CRED iQ has analyzed loan modifications during this period of significantly elevated interest rates.

“The number of modifications in 2023 more than doubled compared to 2022,” they said. “Of the $162 billion in securitized commercial mortgages which matured in 2023, 542 loans were modified with cumulative balances just over $20 billion, which is a 150% increase from the amount of modifications that occurred in 2022. According to CRED iQ’s 2024 CRE Maturity Outlook, 2024 will see $210 billion in securitized maturities. CRED iQ predicts that the modification trend will continue to surge as more special servicers decide to ‘pretend and extend’ versus foreclose on these commercial properties.”

In office, 26% of $35.8 billion in CMBS loans that matured last year were paid in full. Borrowers either couldn’t get refinancing (which likely would have meant a heft injection of equity into projects) or couldn’t sell for a price that allowed them to gracefully exit the stage.

Since February 2022, so two years, 593 office loans transferred to special servicing. Out of them, 13.7% were modified, 14.0% returned to the master servicer as corrected, 8.4% were paid off, and the remaining 63.9% are still with the special servicer.

“Extending the loan term has been the most popular modification type in 2023 and so far in 2024 (excluding grouping categories Other and Combination),” they wrote. “By deal type, CRE CLO deal led all categories and comprised nearly half of all loan modifications, followed by SBLL deals.”

CRED iQ gave two examples of the largest loan modifications to date — 1.6 million square feet One Market Place in San Francisco and 249,063 square foot mixed use in the Chelsea submarket of New York City. Well enough, but how long can this go on without investors, regulators, or others demanding a permanent ending?

 

Source:  GlobeSt.

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Spread Between Corporate Debt and CRE Mortgages Hits 24-Year High

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In its recent look at U.S. capital trends, using the most recent data through 2023, MSCI look at what it called debt snapshots — a handful of considerations that help explain how troublesome CRE debt markets are at the moment.

The first was the spread between corporate debt and CRE debt and how it has risen to a high at least when looking at figures from the last 24 years. It was more relatively costly to finance a commercial property through a direct mortgage.

“The spread between commercial mortgage rates and corporate bonds widened to an average of 121 basis points over the last six months of 2023,” MSCI wrote. “Looking back to 2000, mortgage rates were at a comparable high relative to the cost of corporate debt only in the worst parts of the GFC. And even then, the spread was only at high levels for three months.”

After the Great Financial Crisis, the gap between corporate and CRE mortgage debt averaged only about 9 basis points between Moody’s Baa corporate bond yield and 7-year and 10-year commercial mortgage rates.

Connected to the cost is the perception of risk. According to Moody’s, the definition of Baa credit is, “Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.” The added spread for CRE mortgage rates suggests that commercial mortgages are even riskier. Given market jitters and concerns about default, that shouldn’t be surprising.

Higher interest rates do put a sting into transactions and refinancing, but investment funds are feeling the pinch, MSCI said. “On the performance side, it has also had an impact on investor returns,” they wrote. “The MSCI/PREA U.S. ACOE Quarterly Property Fund Index ended 2023 with an annual net total return of -12.6%, and a pure leverage impact of -396 basis points (bps). The mark-to-market on outstanding debt contributed a positive 13 bps but this gain only slightly offset the pure leverage impact and means the total impact of debt was -383 bps.”

And when interest rates are higher than returns on investments, debt becomes dilutive. MSCI estimates that interest rates on outstanding debt went from 3.4% in June 2022 to 4.5% by December 2023. Property returns for the year were -8.3%.

“As a core fund index, leverage levels in the index are relatively low, with debt representing 25.7% of gross asset value as of the end of 2023, though this is up from 20.9% in March 2022, largely due to asset value declines. For funds outside the core space that carry higher debt loads, the dilutive impact of debt would likely have been felt even more acutely.”

So far, bank loan delinquency rates have been “rising, not surging.” However, as GlobeSt.com has separately reported, there have been questions of whether lenders have been indulging in “extend and pretend.” Stretching renewal dates means not having to take immediate hits on balance sheets. That can work for a while, but only so long.

 

Source:  GlobeSt.

 

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How Sale-Leasebacks Help PE Raise Capital In A Tight Market

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Funding for growth, refinancing corporate debt, and merger and acquisition activities are top priorities for many private equity firms. A recent PwC report noted that 60% of CEOs plan to make at least one acquisition in the next three years. The report further explains that lower levels of M&A activity during 2023 created “pent-up buyer demand” moving into the current year. However, tapping into capital isn’t always easy when it is locked in assets.

“It’s quite inefficient for private equity firms to have capital tied up in real estate assets that aren’t earning for them,” says Tyler Swann, managing director, investments at W. P. Carey. “An alternative is doing a sale-leaseback, which provides a much lower cost of accessing capital than traditional financing methods.”

Understanding sale-leasebacks and their advantages can help private equity firms strategically manage growth funding, debt maturities and other capital needs.

 

The Advantages of Sale-Leasebacks

With traditional financing strategies such as mortgages, terms are often shorter and exposed to higher market volatility. Accessing capital can also be time-consuming, a challenge for firms that need to move quickly for acquisition deals. That’s not the case with sale-leasebacks, notes Swann.

“Sale-leasebacks are very flexible,” says Swann. “The processing time can be as short as 30 to 45 days between the initial call and the actual funding. It’s not unusual for us to get a call from a private equity firm saying, ‘We’re closing on a business in 30 days; can you be there to close with us as acquisition financing?’ And that’s something we can do.”

He explains that capital uses also have very few restrictions, with the most common purposes being acquisition financing, dividend payments, and refinancing maturing debt.

 

Misconceptions About Sale-Leasebacks

As private equity firms consider sale-leasebacks, questions often linger regarding who qualifies for this type of financing. Many believe that because their real estate is in a secondary or tertiary market, or their asset doesn’t have a huge value, they won’t qualify. But according to Swann, that’s not necessarily true.

“If you have a specialized manufacturing facility in a small market, you may think it won’t qualify because it’s not a high-quality warehouse in a market like Southern California,” says Swann. “Despite where an asset is located, if it’s profitable and contributing to the bottom line of a business, it could be a great candidate for a sale-leaseback.”

As the market progresses through 2024, Swann expects sale-leaseback activity to continue upward, partly due to M&A activity and its flexibility to tap into capital quickly.

“Every year, sale-leasebacks become a little more accepted in the private equity community as a source of financing,” says W. P. Carey’s Swann. “Ten or 20 years ago, corporate debt was by far the dominant option, but we continue to see an increase in sale-leaseback deals every year.”

 

Source:  GlobeSt.

 

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How One Net Lease Giant Plans to Deal With Debt Maturities

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Debt maturities are a big consideration in all areas of commercial real estate, including net lease. The topic came up in most recent earnings call for Global Net Lease (GNL), one of the largest public REITs focused on net lease.

The reason for a focus on debt maturities and the connected topic of interest rates is because they put pressure on all CRE businesses. The stock price reflects concerns about macroeconomics and finance. There was a sharp plummet starting late February 2020, which makes sense given pandemic-related shutdowns of retail businesses. With the advent of successful vaccines, the price regained ground to within a couple of dollars by June 2022, and then came the Federal Reserve’s reaction to inflation — a series of sharp and quick rate hikes. And the stock started falling again, from $19.90 to $7.56 as of March 18, 2024.

The expected wave of CRE loan debt maturities is a problem across CRE. That includes net lease properties.

“GNL is implementing a 2024 business plan focused on deleveraging its balance sheet, reducing its exposure to variable rate debt and driving down its net debt to adjusted EBITDA,” said co-CEO Mike Weil during the most recent earnings call. “Our near-term strategic priority will focus on reducing leverage through select dispositions, prioritizing noncore assets and opportunistic sales.”

He further said that assets targeted for disposition include both non-core and those that have near-term debt maturities or implied-term lease expirations. The latter is important because the company focuses on investment-grade or near-investment-grade tenants, with 58% of their tenants in that category. Single-tenant retail represents two-thirds of the investment-grade or implied investment-grade tenants. If a significant portion of the lease expirations are among these tenants, turnover would put more financial pressure on the company.

The largest segment of their portfolio is industrial and distribution, and that segment has been seeing pressures of late that had once seemed to pass the category by.

“Total annual industrial leasing activity fell to 790 million sq. ft. in 2023 from a record 1 billion sq. ft. in 2021 and was not enough to offset the large amount of new supply,” wrote CBRE earlier in March. “As a result, the overall industrial vacancy rate jumped by 180 basis points (bps) last year to 4.8%, returning to near its 10-year average of 4.7%. Developers predictably became more hesitant to break ground and construction starts fell to 46.3 million sq. ft. by Q4 2023 from a quarterly average of 102.5 million sq. ft. in 2022.”

“GNL has a plan to address the remaining 2024 debt maturities through dispositions, refinancing and availability on the credit facility,” said chief financial officer Chris Masterson. “We will continue to address the 2025 maturities and anticipate that the second half of 2024 will present a more favorable environment for debt maturities beyond 2024, but we remain confident in our ability to refinance these assets.”

 

“We expect a total of $400 million to $600 million of strategic dispositions in 2024,” Weil said. “This disposition program will drive long-term shareholder value by generating cash to enhance and derisk our balance sheet and create a clear path forward for us to potentially narrow the trading discount compared to our net lease peers. Selling assets at attractive cap rates will also provide proof of value to investors and demonstrate a significant premium compared to where the company is currently trading on an implied cap rate basis.”

 

Source: GlobeSt.

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Law Firm Office-Leasing Activity Hit Milestone In 2023

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The legal industry leased more office space last year than it has since the Covid-19 pandemic.

In 2023, U.S. law firms leased a collective 16.9 million square feet, according to Cushman & Wakefield. That’s not only more office space leased by the sector since the Covid-19 pandemic, but exceeds the amount leased nationally by law firms in 2017, 2018 and 2019, as tracked by Cushman.

The legal industry has bucked the broader trend of office-market leasing since the pandemic upended norms around office-space usage. While law firms, like other industries, have taken a hard look at their office real estate, they on the whole are using the office more regularly than other industries. Therefore, they’ve occupied a more robust segment of the leasing market while other industries have slowed their deal activity, put spaces on the sublease market or exited big chunks of space.

For those in commercial real estate who work with law firms on their office-space needs or otherwise track the industry, the legal sector’s recent leasing activity is indicative of its new normal.

Many law firms that saw their leases expire in 2020 or 2021 inked a short-term extension because of the uncertainty during the height of the pandemic. But in the past two years, law firms have gone back to the office more frequently and overall feel more confident making longer-term decisions about their space, said John McWilliams, senior research analyst at Cushman.

The biggest relocation signed by a law firm since the pandemic, according to Savills, was Paul, Weiss, Rifkind, Wharton & Garrison LLP’s deal inked late last year. The international law firm agreed to take 765,931 square feet at 1345 Avenue of the Americas in Manhattan. Not only was it the largest law office relocation since the pandemic, it was also the largest office lease signed across all industries and the U.S. last year.

What Law Firm Leasing Activity Says About The U.S. Office Market

Although it’s only one sector — and legal tenants only made up 8.8% of the national leasing market in 2023, according to Savills — how this industry is making office-space decisions is somewhat indicative of broader trends affecting the U.S. office market.

For example, like many professional-services tenants, law firms are largely seeking to be in the top 10% of office buildings in the markets they’re in, McWilliams said. Many law firms that have made leasing decisions in the past couple of years have departed office buildings that, while not necessarily Class B or C space, are no longer considered the top-tier towers in town.

Notably, a growing share of legal-industry tenants have decided to renew their leases in their current buildings rather than relocate, which may be indicative of the shrinking amount of top-tier office space available in a given market. That’s especially true of office tenants that require 100,000 square feet or more.

Data from Savills found, in 2023, 56% of leases signed within the legal sector were stay in place, compared to 33.9% in 2022.

And as office space at the high end of the office market is leased, and buildout construction costs are growing, a greater number of legal tenants are considering higher-quality sublease space on the market, experts say.

“Law firms are continuing to put value in office space as part of their recipe for being successful,” said Tom Fulcher, chair of the legal practice group at Savills. “It feels like we’re establishing the new normal in terms of (which industries) want to work in the office or remote … those things are calcifying into what it’s going to be moving forward.”

 

Source:  SFBJ

 

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A New Financing Risk Emerges

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Goldman Sachs Group put together a mortgage-backed bond deal in 2021. Nothing unusual about that. The money went to a group purchasing 61 multifamily properties with a total of 1,719 rent-controlled units in San Francisco. The floating-rate, interest-only, first lien mortgage loan had an initial balance of $674.8 million.

By the end of 2022, the borrowers defaulted, as Mortgage Professional America noted. The loan was sold off at a deep discount, according to Bloomberg. Then came the rest of the bad news. Special servicer Midland Loan Services told the investors of a holdback of $164 million.

Holdbacks happen on occasion in CMBS financing, but this was big. As Bloomberg noted, it exposed multiple classes that had been rated as investment grade by Kroll Bond Rating Agency to potential loss and has raised fears among some investors that servicers will make surprise decisions that affect their returns in deals.

In February 2023, Fitch Ratings gave the overall package, GSMS 2021-RENT, a AAA investment-grade rating, with an explanation of key rating drivers.

“The affirmations reflect stable servicer reported net cash flow (NCF) and improved occupancy since issuance,” the agency said at the time. “According to the September 2022 rent roll, portfolio occupancy for the residential units has improved to 88.9% compared to 74.7% in December 2020 when portfolio occupancy had been impacted by the pandemic. Fitch’s NCF has improved to $34.2 million compared to Fitch’s NCF at issuance of $27.1 million and YE 2020 servicer-reported NCF of $28.0 million due to the improving occupancy.”

 

The firm also noted, “The Veritas Multifamily Portfolio Pool loan transferred to special servicing on Nov. 3, 2022 due to imminent maturity default. The sponsor, a joint venture between Veritas Investments and affiliates of Baupost Group, indicated it was not going to exercise its one-year extension option or be able to pay off the loan at the scheduled loan maturity in November 2022. As of February 2023, the lender and borrower were negotiating a potential cooperative sale of the properties to a third party along with other potential workout options.”

The collapse of a highly-rated mortgage-backed bond might bring up memories of the Global Financial Crisis in which many bonds backed by residential mortgages with strong ratings were found to be less than what they appeared.

This has reportedly spooked Wall Street and investors. They already see a big downturn in markets, as GlobeSt.com has extensively reported. The prospect of special servicers holding back payments adds to the risk. Some of the investors in the deal reportedly were Angelo Gordon, LibreMax, and Lord Abbett.

“This is a risk investors did not expect,” Stav Gaon, a strategist at Academy Securities Inc., told Bloomberg. “There’s no reason to think that something like this won’t happen again.”

He also said that there may have been a good explanation of the action, and that it was likely the biggest such action in that type of security.

 

Source:  GlobeSt.

 

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Stagflation Is a Real Possibility to These Analysts

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A drumbeat for stagflation as a possible scenario for the US economy is growing louder.

Last week, strategists from the Bank of America wrote that the macroeconomic picture is “flipping from goldilocks to stagflation,” which they defined as growth below 2% and inflation of between 3% and 4%. Inflation is higher in developed and emerging markets, while the US labor market is “finally cracking,” wrote Michael Hartnett.

JPMorgan Chase’s Marko Kolanovic raised similar concerns in February. A halt in inflation’s downward trend, or price pressures broadly resurfacing “wouldn’t be a surprise” given outsized gains in equities, tight labor markets and high immigration and government spending, he said, according to Bloomberg.

Between 1967 to 1980, stock returns were nearly flat in nominal terms as inflation came in waves, with fixed-income investments significantly outperforming while stock returns were nearly flat in nominal terms. Kolanovic sees “many similarities to the current times.”

“We already had one wave of inflation, and questions started to appear whether a second wave can be avoided if policies and geopolitical developments stay on this course,” he said in his note, adding that inflation is likely to be harder to control as stock and cryptocurrency markets add trillions of dollars in paper wealth and quantitative tightening is offset by Treasury issuance.

Recent economic reports back up these analysts: The February Consumer Price Index came in at a higher-than-expected 3.2% year over year. Retail sales reported on Friday rose 0.6% from January to February, falling short of projections expecting 0.8% growth.

The Wall Street Journal highlighted these developments but ultimately dismissed the idea of stagflation taking hold in the US economy. So have the equity markets,

Barclays Plc strategist Emmanuel Cau wrote in a note that was reported in Bloomberg.

“With the Fed so far endorsing current market pricing of three cuts starting in June, investors continue to see the glass half full on the soft landing narrative,” he said.

This week the Federal Open Market Committee will meet and the minutes it releases will show how Fed officials’ thinking changed from recent bad data on inflation.

One sign doesn’t bode well for Fed watchers hoping for rate cuts to happen sooner than later.

More than two-thirds of academic economists polled by the Financial Times believe that the Federal Reserve will be forced to hold interest rates at a high level for longer than markets and central bankers anticipate. Respondents to the FT-Chicago Booth poll think the Fed will make two or fewer cuts this year with the most popular response for the timing of the first cut split between July and September.

“The Fed really wants to cut rates. All of the body language is about cutting. But the data is going to make it harder for them to do it,” Jason Furman, an economist at Harvard University, who was one of 38 respondents polled this month, told the FT. “I expect the last mile of inflation to prove quite stubborn.”

However, there is one viable theory for rates in June. Vincent Reinhart, a former Fed official who is now chief economist at Dreyfus and Mellon, told the FT that politics will play a role in the timing this year.

“The data say the best time to cut rates is September, but the politics say June,” said Reinhart, who did not participate in the poll. “You don’t want to start cuts that close to an election.”

 

Source:  GlobeSt.

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Janet Yellen Says Rates Will Be Higher For Longer

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It’s “unlikely” that market interest rates will return to levels before the pandemic, US Treasury Secretary Janet Yellen said to reporters yesterday in comments that were published by Bloomberg.

A reporter asked Yellen why the White House projections that were part of President Joe Biden’s $7.3 trillion fiscal 2025 budget proposal showed higher expectations for interest rates in coming years compared with projections a year ago. Yellen said the new numbers were in line with private sector forecasts.

“I think it reflects current market realities and the forecasts that we’re seeing in the private sector — that it seems unlikely that yields are going to go back to being as low as they were before the pandemic,” she said.

The budget proposal now assumes that the rates on three-month US Treasury bills will average 5.1% this year, up from the 3.8% projected last March. The projection for the 10-year yield is now 4.4%, up from 3.6%.

Meanwhile, some economists are beginning to think that it will be a long time for the Fed to reach its goal of 2% inflation and that 3% will be the new normal.

“Inflation was able to decelerate from 9% to 3% rather quickly, but the path to the Fed’s 2% target may take more time than expected,” Skyler Weinand, CIO of Regan Capital, told Axios.

Last week, the Labor Department reported that the Consumer Price Index grew 3.2%year over year.

Lara Rhame, chief U.S. economist at FS Investments, also believes that inflation will hover at 3% for the foreseeable future.

The Fed is “going to err on the side of caution in terms of cutting too quickly,” Rhame said to Axios.

 

Source:  GlobeSt.

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Powell: ‘There Will Be Bank Failures’ Caused By Commercial Real Estate Losses

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Federal Reserve Chair Jerome Powell said Thursday he expects to see some banks fail due to their exposure to the commercial real estate sector, which has declined significantly in value following the shift to remote work.

Powell said the banks that are in trouble with falling office space and retail assets are not the big banks, which were designated as “systemically important” in the aftermath of the 2008 financial crisis. That episode, which resulted in a taxpayer bailout of the financial sector, was also triggered by unsound real estate assets.

Rather, the banks at risk of failure now Powell identified as smaller and medium-sized.

“This is a problem we’ll be working on for years more, I’m sure. There will be bank failures,” he said during a Thursday hearing on the Fed’s monetary policy in the Senate Banking Committee.

“It’s not a first-order issue for any of the very large banks. It’s more smaller and medium-sized banks that have these issues. We’re working with them. We’re getting through it. I think it’s manageable, is the word I would use,” he said.

Powell didn’t go into detail about the specific regulatory actions regarding commercial real estate exposure that are now being undertaken by the Fed, which is both the federal currency issuer and one of the primary bank supervising agencies, though he did say he had identified the banks most at risk.

“We are in dialogue with them: Do you have your arms around this problem? Do you have enough capital? Do you have enough liquidity? Do you have a plan? You’re going to take losses here — are you being truthful with yourself and with your owners?” he said.

Commercial real estate investment trusts, known as REITs, have taken a hit over the past few months. Alexandria Real Estate Equities, Boston Properties, Kilroy Realty Corp., and Vornado Realty trust are all in negative territory since the beginning of the year.

Powell described the decline in value of commercial real estate as a result of remote work following the economic shutdowns of the pandemic as a “secular change” in the economy.

“In many cities, the downtown office district is very underpopulated. There are empty buildings in many major and minor cities. It also means that all the retail that was there to serve those thousands and thousands of people who work in those buildings, they’re under pressure, too,” he said. 

While the decline of commercial real estate values could put some banks out of business, Powell expressed confidence that the Fed and financial regulators would be able to contain the fallout and prevent a broader crisis. Thirty-four U.S. banks have failed since 2015, according to the Federal Deposit Insurance Corp. (FDIC), which insures deposits at regulated banks.

 

Source:  The Hill

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Ron Osborne Recognized As Sperry Commercial Global Affiliates Top Producer For 3rd Consecutive Year And Top Producing Office For The First Time

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Ron Osborne, Managing Director/Broker of SperryCGA | RJ Realty, has been recognized as a Top Producer at Sperry Commercial Global Affiliates for the third consecutive year.

Each year, the firm bestows this esteemed accolade upon the top 10 brokers who achieve the highest grossing volume.

“Over each of these years, I have consistently elevated my production levels, culminating in being honored as the 2nd highest producer in 2023,” commented Osborne. “This remarkable accomplishment is largely a result of the unwavering trust my clients have placed in my abilities, along with the invaluable support from my colleagues, family, friends, mentors, and influential figures in the business community. As I settle in to 2024, I am confident that with that continued support, I will be reach my ongoing aspiration of attaining the coveted position of Top Producer.”

The firm, RJ Realty, was also recognized as a Top Producing Office in the Sperry network of 60+ offices.  Mr. Osborne the Managing Director/Broker, attributes the honor to the hard work of his team.

The team is laser focused on clients’ needs and helping them achieve their goals. Most of RJ Realty’s clients have worked with Mr. Osborne for years and consider him and his team part of their advisory team.  The RJ Realty team always puts the client’s needs first, from assisting them in financing a new acquisition, to helping them determine the right time to exit a property.  Ron always advises his clients not to just buy for a return on the investment, but to also place location as just as important – sometimes even more than the current cap rate.

 

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