Triple-A-rated bonds on office towers throughout the U.S. are under stress, hitting bondholders with double-digit losses not seen since the Great Recession of 2008, Bloomberg reports. The unluckiest bondholders are not even being paid any of the interest they’re owed.
With 38% of U.S. workers either working remotely or in hybrid setups, commercial real estate occupancy and rents are down. That’s dragged the value of even storied office buildings, in many cases, to one-third their value, causing some of the buildings to default on their mortgages and putting some into foreclosure.
The rise in artificial intelligence and e-commerce is making the CRE outlook even bleaker.
The result is, buyers of even the safest commercial real estate bonds are getting stuck with losses of 20%, 30% or higher — something that has not happened since the 2008 financial crisis.
Take 1407 Broadway in the Garment District of New York. Wall Street financiers considered the 43-story tower a rock-solid money-minting machine. That prompted the owners to float a AAA-rated $350 million bond backed by the building’s rental income in 2019. Not even Treasury bonds get that high a rating.
But this past June, investors in the AAA tranche of the debt were informed they would not get their $1 million monthly interest payment. Now the investors are foreclosing on the building to salvage what they can of their investment.
Owners of AAA bonds on this and similarly once-esteemed properties are set to reap only about one-third of their original investment, while lower-ranking investors may be completely wiped out.
“There will be deals that are horrific, where the AAAs may not be paid off in full and there’s basically no bid for the asset,” says TJ Durkin, head of structured credit and specialty finance at TPG Angelo Gordon. “The investment community thought the real estate would never become obsolete. It ended up being wrong.”
Some bonds have stopped paying the full interest amount owed to creditors because rental income has dropped and servicing mortgage debt has become more expensive in a high interest rate environment.
Appraisals are coming in $170 million to $226 million lower on major properties — not just 1407 Broadway but also River North Point in Chicago and 725 South Figueroa Street in Los Angeles.
The top-rated slice of a $115 million bond on Peachtree Center in Atlanta is being quoted at 55 cents on the dollar. S&P Global Ratings originally rated the debt AAA when it was issued in 2018. It’s since been reduced 17 levels to CCC.
Two-thirds of a skyscraper remains vacant at 600 California Street, just a few blocks from the famed Embarcadero in San Francisco. Bondholders of debt tied to that property are owed $6 million in back interest.
Another stressor on CRE debt is the issuance of a new breed of bonds that became popular after the 2008 crisis: a Single-Asset, Single-Borrower (SASB) bond tied to just one building. With commercial real estate historically so strong, SASBs seemed a no-brainer, and the market expanded to $300 billion. But the COVID lockdowns turned SASBs on their head.
Whether for a CRE bond tied to multiple properties or a SASB, “the AAA rating is designed to be a debt security that would typically default less than once every 5,000 years,” says John Griffin, a professor of finance at the University of Texas at Austin. “Yet here we are not far from the financial crisis observing defaults. It does not appear that the major issues in structured finance have been fixed.”
There are some bright spots, however. SASB sales have totaled $56 billion so far this year, on par with sales before the COVID pandemic. Buyers are interested in newer buildings in prime spots in the biggest U.S. cities. Some are investing in distressed properties, like Gas Company Tower at 555 West 5th Street in Los Angeles. Worth $630 million a few years ago, Los Angeles County is now trying to buy the building out of receivership for $200 million.
Also, while regional banks continue to grapple with their office loan books, rate cuts may provide some relief, even with a looming “maturity wall” for $950 billion in CRE mortgage debt refinancing maturing in 2024, analysts say.
As Lea Overby, a commercial mortgage-backed security strategist at Barclays, puts it, “The commercial mortgage bond market is a world of have and have-nots right now.”
Jason Benowitz, a senior portfolio manager at investment firm Segall Bryant & Hamill, does not foresee a winding down of CRE troubles for many years.
Lee Barney ✉
Lee Barney, Newsmax’s financial editor, has been a financial journalist for 30 years, covering the economy, retirement planning, investing and financial technology.
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