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Good morning. With U.S. commercial real estate under mounting stress, banks show a growing willingness to amend loan terms to avert defaults. Meanwhile, NYC's public housing, overseen by NYCHA, is in a critical state. Projections suggest a $78B rejuvenation needed in the coming two decades.

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How U.S. Banks are Revamping Property Loans to Minimize Defaults

In response to the escalating pressure on the U.S. commercial real estate sector, banks are increasingly demonstrating readiness to rework loan terms to prevent defaults.

Mitigating losses: In an effort to avert these losses, banks have enhanced their strategies based on insights from CRE analysts and industry data. Measures include offering loan extensions and modifications, selling derivatives to set interest costs, and providing subsidized loans for investors to buy defaulted loans. The aim is to weather the current situation, hoping that these properties will return to profitability and refinance when interest rates decrease.

Bank-borrower cooperation: Shaishav Agarwal, Global Head of CRE Capital Markets at Deutsche Bank, highlighted the proactive approach of banks to help borrowers avoid defaults. In extreme situations, banks might partner with equity partners possessing property management expertise to manage defaulting properties. However, some analysts argue this "extend and pretend" approach could falter if sector stress escalates.

Sector vulnerability: Steve Jellinek, Head of Commercial Mortgage Backed Securities (CMBS) research at DBRS, flagged the office sector as facing severe challenges. If major losses accumulate on banks' books, it could restrict credit availability and hinder economic growth. Data from the U.S. Federal Reserve reveals that the 23 largest U.S. banks held 20% of office and downtown retail CRE loans. Significant exposure to CRE loans is also seen among smaller banks.

Loan Modifications: Recent data indicates banks' strategy of modifying loans is successfully reducing defaults. A substantial 36.5% of office loans, amounting to $2.1 billion, maturing in May saw modifications or extensions – a significant change from no alterations in the Feb-April period. While defaults might rise to 6% by end-2023, they're predicted to stay below the 10% peak seen during the financial crisis.

➥ THE TAKEAWAY

Pricing expectations dilemma: While the interest of funds in buying undervalued assets is helping banks minimize large losses, a notable challenge is a mismatch in pricing expectations. Banks are offering non-performing loans at 20-25% discounts, whereas investors are hunting for deeper cuts. This discrepancy could create obstacles as the sector attempts to navigate through tumultuous market conditions.

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Near $80B Revamp Essential for NYC's Public Housing Infrastructure

New York City's public housing system, managed by the New York City Housing Authority (NYCHA), is in dire need of a massive repair and renovation effort. Estimates say a $78B overhaul will be required in the next 20 years.

Rising costs and challenges: This financial estimate marks a 70% increase since the last calculation in 2017. The sharp increase is due to inflation and escalating construction costs, demonstrating the mounting challenges faced by city officials and the NYCHA. Out of the total sum, $60 billion is expected to be utilized in the next five years for replacements, such as boilers and heating systems. This is nearly six times the estimate made in 2006.

NYCHA's role: The NYCHA is an essential part of NYC, providing affordable housing options to a vast number of city residents. It houses over 330,000 individuals, equivalent to populations of cities like Orlando or Pittsburgh. Notably, more than 40% of families residing in NYCHA homes include a working member. However, the public housing system also caters significantly to the city's elderly population living on fixed incomes.

Historical challenges: NYCHA's system, once considered a progressive accomplishment, has faced numerous obstacles over time. Many of the buildings, constructed in the mid-20th century, are now overdue for renovations. Funding shortages, mismanagement, and inefficiency have exacerbated the situation, with federal investigations leading to the appointment of a federal monitor in 2019.

The search for solutions: Various mayoral administrations have approached NYCHA's predicament differently. The current Mayor Eric Adams aims to privatize the developments under a federal program established by President Barack Obama. Such a move would permit access to billions in loans and subsidies but could also result in building demolitions.

➥ THE TAKEAWAY

Big picture: New York City's public housing crisis highlights the pressing need for a radical overhaul in urban housing policies. The city's struggle to secure sufficient funding for NYCHA underscores the broader issue of the sustainability of public housing programs in major cities across the US. While the shift towards privatization could provide the necessary financial injection, it's imperative to ensure that the most vulnerable populations don't bear the brunt of these changes.

• Best-kept secrets: More multifamily owners are discovering the benefits of a little-known federal program that allows families in subsidized housing to save money by recapturing rent increases.

• Messi mania: Lionel Messi's arrival in Miami is causing more buzz than LeBron James, leading to stadium expansions, a surge in hotel bookings, and increased publicity for local restaurants.

• CRE litigation: High interest rates and post-pandemic trends may lead to lower valuations in commercial real estate, especially offices, causing potential litigation over loan control.

• LA mixed-use: Caruso has secured $450M in refinancing for the retail section of The Americana at Brand, a mixed-use property in Glendale, California.

• Alternative capital: With tighter capital markets and volatility, JVs are gaining even more attention in the REIT industry.

• Handing back the keys: Brookfield is stepping away from yet another office property, marking the Brill Building in Midtown Manhattan as its latest casualty.

• Seniors Housing outlook: Despite economic challenges, a CBRE survey predicts rental rate increases of 3% or more in most senior housing classes, with assisted living leading the way.

• Maximum donations: Billionaire real estate developer Harlan Crow is among the wealthy donors supporting Florida Governor Ron DeSantis's campaign.

• Private assets: Fidelity Investments Canada ULC has partnered with Brookfield Asset Management to launch a new private real estate market portfolio.

• Make it work: A CBRE report forecasts cap rates to climb in late 2023 due to increased borrowing costs and economic instability. Here’s how to make it work in your favor.

• Heloc boom: Higher mortgage rates have resulted in a shift towards home equity lines of credit as homeowners in the US tap into approximately $9T of real estate wealth.

• One of a kind: Dacra, led by Craig Robins, plans to add a 20-story rental building to the Miami Design District, a first for the luxurious retail neighborhood.

• Nightmare at Nightingale: Investors in Nightingale Properties' projects have received an update on the fate of their funds, but it is not the news they were expecting.

• Water efficiency: A Saudi firm exploited lax regulations to extract significant water resources in arid Arizona. Now, the nearly decade-long arrangement faces potential disruption.

Property owners are grappling with plummeting cash flows and escalating operational expenses. Some opt to sell at a loss, while others, including LA's Kearny Real Estate, are pivoting, transforming office spaces into warehouses, residences, medical facilities, data hubs, and hospitality venues.

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