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They were like haute couture for the real-estate world.
Investors in a new model of mortgage bonds created over the past decade to finance trophy commercial real estate and star property owners are about to find out what higher mortgage rates mean as a mountain of debt comes due.
More than $45 billion of loans on some of the nation’s most recognizable office buildings, hotel chains and other commercial properties are set to mature through 2024, debt that was tucked away into bond deals known as single-asset, single-borrower (SASB) securities, according to a tally by DBRS Morningstar.
The bonds, tied mostly to large loans of $200 million to $1 billion each, helped finance high-end buildings and well-heeled borrowers in the era of rock-bottom interest rates that prevailed in the wake of the 2007-2008 global financial crisis.
Now, owners of many of these office towers, hotels and multifamily developments soon face big, balloon payments to satisfy their debts in cities and towns across the nation altered by the pandemic. Loans also have become more costly to take out, and harder to come as the Federal Reserve wages its battle against high inflation.
“Everybody is going to be watching this,” said Zach Streit, a founder of Way Capital, a debt and equity commercial real estate advisory firm in Los Angeles.
“It’s the head of the dog, because it is some of the largest assets, with the biggest sponsors,” Streit said, adding that what happens in the large-loan market will filter into everything else.
Iconic, but concerns
Lending at low rates helped propel commercial property prices to record highs during the pandemic, helped along by annual mortgage bond issuance that in 2021 hit a 14-year high of nearly $140 billion, according to data from the Securities Industry and Financial Markets Association.
The trend on Wall Street for decades had been to bundle up dozens of smaller commercial property loans into $1 billion bond deals, to help diversify the risks. The twist over the past decade was to lean heavily into debt that hinged on a single, trophy asset or top real estate owners.
Some of the buildings, like the sprawling Parkmerced apartments in San Francisco transformed neighborhoods, while the Seagram Building on Manhattan’s Park Avenue has been credited with giving rise to sleek, modern skyscrapers.
Bond investors often jumped at the chance to own even a sliver of debt on iconic buildings, but now both Parkmerced and Seagram sit near the top of a pile of maturing large-loans “of concern” for 2023 and 2024, according to lists compiled by analysts at DBRS Morningstar.
To be sure, concerns about maturing debt on specific buildings only point to potential trouble ahead, not a guarantee of it. High-profile real estate operators often have many options to avoid defaulting, such as writing a bigger equity check when looking to refinancing, bringing in other forms of capital or additional partners, or even selling a property.
Also, while the DBRS Morningstar analysts pegged the loan payoff rate for mortgages in single asset, single borrower property bond deals at a low 62% in 2022, they expect roughly 75% of loans to pay off this year and 94% in 2024.
A spokesman for RFR Realty, owners of the Seagram Building, declined to comment. Parkmerced owners Maximus Real Estate Partners didn’t immediately return a call or email seeking comment.
A ‘new reality’
Trophy buildings in places like Manhattan and San Francisco were long known for retaining their appeal in past economic downturns, at least before the pandemic changed expectations around working from the office five days a week.
San Francisco has been reeling from a wave of layoffs in the technology sector in recent months, but also has been one of the slowest big U.S. cities to recover from the pandemic.
Weekly office occupancy rates for the New York and San Francisco metro areas were still pegged below 50% in early February, according to Kastle System’s 10-city national average
Many commercial property owners made use of loan extension options available during the pandemic, which could be running out right as loans come fully due as interest rates reset higher. Many loans in the past decade required borrowers only to pay interest, but not to shrink their loan balance.
Specifically, the Parkmerced loan “of concern” carries a low 3.25% fixed rate, and it comes due in December 2024, according to the DBRS report, while other floating-rate loans carried rates as high as 8.47%
Many fixed-rate property loans are based off the 10-year Treasury yield
TMUBMUSD10Y,
plus some basis points, to compensate for default risks. Treasury yields rose and U.S. stocks
SPX,
were heading lower over the past week on concerns about how long the economy might face even higher interest rates as the Fed keeps up its inflation fight. The benchmark 10-year was at 3.73% on Friday.
“Right now, rates probably are in the high 5s to mid 6% range,” said Anuj Gupta. chief executive officer of A10 Capital and a veteran commercial real estate lender.
Gupta expects a portion of the maturing, floating-rate debt in bond deals to qualify for refinancing into longer, fixed-rate loans, but he also sees borrowers who might need to put more equity to properties as prices wobble, or the use of more costly mezzanine debt and other forms of funding to stabilize buildings.
“I do think the real-estate market has already capitulated to a new reality,” he said.
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