CityPoint, a 36-story office building in London’s financial district, became one of the symbols of the financial crisis when a Beacon Capital Partners Inc. fund missed a payment on loans secured by the property just over a decade ago.
(Bloomberg) — CityPoint, a 36-story office building in London’s financial district, became one of the symbols of the financial crisis when a Beacon Capital Partners Inc. fund missed a payment on loans secured by the property just over a decade ago.
As the turmoil receded, Brookfield Asset Management Inc. eventually took over the tower. Now, the rise of work from home and surging interest rates mean Bank of America analysts are warning that a default on loans linked to the property is likely.
The building isn’t alone in facing a wobble having become tangled up in problems after the 2008 crisis. An office complex in Frankfurt and towers in New York are also running into difficulties again.
The various troubles highlight how low borrowing costs led many investors to become comfortable holding properties with a tarnished history, betting it would be different this time.
But now, many large occupiers are focused on the best quality buildings and the relics of the last crash are struggling to hold their value. Morgan Stanley analysts forecast that US commercial real estate prices will fall by more than they did in the financial crisis.
“The low cost of debt due to quantitative easing has led to the same property value expansion as observed during the previous cycle,” said Nicole Lux, a senior fellow at Bayes Business School whose research areas include real estate finance. “Lenders and investors now have to admit that they are facing the same refinancing issues for their properties.”
Brookfield is initiating discussions for an extension of the debt and is confident it will be repaid in full when the building is eventually sold, according to a person with knowledge of the matter. It has a plan to boost leasing in the near term and has reduced the loan-to-value ratio since commercial mortgage-backed securities linked to the building were issued in 2018, they said.
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The issues reflect a wider trend in credit, where some companies that have undergone restructurings in recent years are back in distressed territory. Spanish gambling operator Codere, for example, is trying to raise rescue financing as part of its fourth debt restructuring since 2015.
In real estate, an industry that relies more than most on leverage to boost returns, the results are similar. Banks are now demanding more equity in return for refinancing loans to protect themselves from any further declines, and buyer interest has dried up as yields on safer investments increase.
That’s left a number of buildings previously sold out of distressed situations looking potentially shaky once again.
Loan Risk
Germany’s biggest office property, The Squaire, a curvy building that houses companies like KPMG and Michelin near Frankfurt airport, is a good example.
It was developed by IVG, once Germany’s biggest property company by market value before it filed for insolvency in 2013. The Squaire was then bought by a consortium that included South Korea’s Hana Financial Group for almost €1 billion ($1.1 billion) in December 2019, just months before the pandemic upended the real estate market.
Two years ago, the building was refinanced in a commercial mortgage backed securities deal arranged by Bank of America, which valued the property at €833 million. The total interest-only loan was €540 million and included a 10% increase in the senior debt, according to a report from Fitch.
The issue is whether a sale now would cover the debt. Analysts at S&P estimate its recovery value at just over €570 million, leaving little room to ensure debt holders get repaid if the owners default. Many of the CMBS notes have been downgraded to reflect that possibility. Hana didn’t respond to a request for comment.
At the time of the financing, there were warnings that the issuance could underestimate the risk posed by post-Covid business travel for a building where proximity to the airport is a key selling point.
Shortly before the CMBS was issued, Deutsche Lufthansa SA moved hundreds of staff out of The Squaire as part of a cost-cutting plan, Bloomberg reported at the time. The vacancy rate rose to 16% at the end of last year, from around 2% in 2019.
“To put more debt on, you know, during the pandemic, felt incongruous,” Euan Gatfield, a managing director at Fitch, said in an interview. “If you weren’t a business that was so geared to business travel you’d probably have a hard time convincing your staff it would be the place to locate.”
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There are similar stories in the US, where Federal Reserve Chairman Jerome Powell has warned that office real estate has been hurt by the rise of working from home and surrounding properties are also suffering in many major cities as a result.
“It feels like some part of that will be persistent and will last,” he said last month.
The potential damage was highlighted in a report Thursday from McKinsey Global Institute. Modeling the impact on valuations by 2030, it said remote work risks an $800 billion hit to the price of office buildings in major cities.
The upheaval has seen US regulators ask lenders to work with credit-worthy borrowers facing stress in the commercial real estate market. Their guidance – which came in the wake of the collapse of a number of regional banks – recommends measures such as payment deferrals.
There are “concerns about the economic conditions as well as more regulatory oversight,” said Jackie Bowie, head of EMEA at Chatham Financial. “The recent bank failures have caused many banks to tighten their lending standards especially in the CRE market.”
Skyscraper Deja Vu
In New York, two towers once owned by developer Harry Macklowe are back in the news for credit reasons. Macklowe lost control of those buildings, plus others, during the financial crisis.
Now, the Chetrit Group has transferred 850 Third Avenue to its lenders while Pearlmark sold the Tower 56 building in the Plaza District at a loss from when it bought the building in 2008.
“Downtown America is still struggling with getting back,” said Apollo Global Management Inc. chief economist Torsten Slok.
The percentage of US CMBS loans in the office sector in special servicing rose to the highest since 2017 last month, according to data provider Trepp. More than half of the $2 billion in loans transferred to a special servicer, which typically happens when there’s a default, were offices.
Canary Wharf
Back in London, some bonds issued by the owners of the Canary Wharf district are being quoted at distressed-level prices as it grapples with the new work-from-home model. Last month, it was dealt a blow when HSBC Holdings Plc decided to move to a smaller building in the City of London.
The pain has echoes with the financial crisis. Qatar increased its stake in the east London financial district in 2009 after the landlord decided to sell shares to repay an £880 million-pound ($1.14 billion) loan after the value of its properties plunged. The country’s sovereign wealth fund subsequently took control of the area with Brookfield in 2015.
Read More: HSBC Quitting Canary Wharf for the City Rocks Docklands District
A short subway ride west, at CityPoint, the Bank of America analysts said in the note last month that a 12-month extension is likely for the loan — “either consensual or via default” — while the parties consider various exit options.
In a downside scenario where the vacancy rate rises, the tower might fall in value to as little as £450 million, they wrote. That would mark a drop of about a third from the current independent valuation.
There’s about £460 million of outstanding debt linked to the building, the person with knowledge of the matter said, and the surrounding area has become more attractive to occupiers with the opening of the transport line linking Heathrow to Canary Wharf.
“At least some of the lessons from previous crises have been forgotten,” said Tolu Alamutu, a credit analyst at Bloomberg Intelligence, who was speaking generally. “The real estate sector may be facing a much more testing outlook than some issuers may be able to weather.”
(Updates with Trepp CMBS data in first paragraph above Canary Wharf subheadline.)
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