Amid the recent record surge in interest rates, the residential housing market may have frozen - as the gap between bids and asks stretches to unprecedented levels - but it is hardly in freefall, courtesy of several years of ultra-low rates which allowed homeowners to lock in low rates for the foreseeable future, even if it means aspiring and new homeowners remain locked out indefinitely of a housing market that has never been more unaffordable (and instead are forced to rent).
But while the residential housing market may be relatively immune against the adverse consequences of soaring rates - if only for a finite period of time - the same can not be said about commercial real estate, where the impact of higher (or lower) rates is transmitted much faster. It's also why the commercial real estate sector is seeing unprecedented pain. A recent example was the bankruptcy of the iconic Times Square Crowne Plaza hotel, located at 1601 Broadway, which as we noted two months ago, reported some 88,000 square feet, or 45% of the office space at this address, was vacant, forcing owners Vornado Realty Trust to take a big L on the property.
Furthermore, as we also mused rhetorically...
Is this the first major commercial real estate domino to fall in the aftermath of covid's "work from home" revolution?
... the answer was clearly yes, and with every day that rates continue rising to multi-decade highs, the headaches for commercial real estate will only grow.
Fast forward to today, when Bloomberg reports that an office landlord controlled by bond giant PIMCO has defaulted on about $1.7 billion of mortgage notes on seven buildings, "a sign of widening pain for the industry as property values fall and rising interest rates squeeze borrowers."
The buildings — in San Francisco, New York, Boston and Jersey City, New Jersey — are owned by Columbia Property Trust, which was acquired in 2021 for $3.9 billion by funds managed by Pimco. The mortgages have floating-rate debt, which led to rising monthly payments as interest rates soared last year.
“We, like most office owners, are addressing the unique and unprecedented challenges currently facing our asset class and customer base,” Justina Lombardo, a spokesperson for Columbia Property Trust, said in an emailed statement. “We have engaged with our lenders on a restructuring of our loan on seven properties within our larger national portfolio. We look forward to a collaborative process yielding thoughtful solutions that reflect current market conditions and best serve the interests of all stakeholders.”
Some more details on the offices in question: a San Francisco building at 650 California St., built in 1964, is the most valuable property in the portfolio at $479 million, according to 2021 figures. Other properties include 229 W. 43rd St., 245-249 W. 17th St. and 315 Park Ave. South in Manhattan, 201 California St. in San Francisco, 116 Huntington Ave. in Boston and 95 Christopher Columbus Drive in Jersey City.
As discussed two months ago, US offices, especially the older buildings with fewer amenities, have struggled in recent years to retain tennants amid the rise of remote work during the pandemic and recent layoffs. According to Green Street, values of those properties have fallen 20% since the onset of the pandemic in March 2020,
The seven buildings owned by Columbia Property Trust were appraised at $2.27 billion in 2021, according to loan documents on a $485 million CMBS that financed part of the debt. Goldman Sachs, Citigroup Inc. and Deutsche Bank funded the original debt of almost $1.9 billion.
The Columbia default follows two weeks after Brookfield Corp., parent of the largest office landlord in downtown Los Angeles, defaulted on loans tied to two buildings rather than refinancing the debt as demand for space weakens in the center of the second-largest US city.
The two properties in default, part of a portfolio called Brookfield DTLA Fund Office Trust Investor, are the Gas Company Tower, with $465 million in loans, and the 777 Tower, with about $290 million in debt, according to a filing. The fund manager had warned in November that it may face foreclosure on properties.
The values of comparable office buildings have broadly dropped, according to the Barclays analysts. Office vacancies have increased across the country since the pandemic made working remotely more routine. The vacancy rate in the Los Angeles central business district vacancy rate was 22.7% in the fourth quarter of 2022, according to a Jones Lang LaSalle Inc. report.
As Bloomberg reports, Brookfield had the option to extend the maturity on the loans tied to the Gas Company Tower, but elected not to. It also elected not to get interest-rate protection that was required for loans for the 777 Tower property, which amounts to an event of default, the company's latest filing said.
The Brookfield DTLA portfolio has a total of $2.28 billion in secured debt, according to a November filing. Other buildings with maturing debt include the Wells Fargo Centers North Tower with $500 million in debt due in October and the Wells Fargo Centers South Tower with $263 million maturing in November. The buildings have about $1.8 billion of floating-rate obligations, generally hedged with interest-rate derivatives, which can translate to increased payments as the Federal Reserve raises interest rates.
The lenders have not foreclosed on the two properties or exercised other remedies available to them, according to Brookfield’s filing. In January, Oaktree Capital Management wrested control of the building known for providing the exterior shots for the main office in the television series “L.A. Law” after the owner, Coretrust Capital Partners, went into default on a loan tied to the property.
Still, despite the recent increase in office-linked defaults, the delinquency rate for commercial mortgage-backed securities for offices is still relatively low, at just 1.83% in January, according to Trepp. It won't stay there long if the Fed continues.
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