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Office Loan Charge-Offs Soar as Lenders Grapple with Mounting Distress

The lending scene in the office sector is displaying worrisome signs, with a spike in delinquency and default rates that hark back to the turbulent times witnessed in 2020’s Q4.

Office Loan Charge-Offs Soar as Lenders Grapple with Mounting Distress

The lending scene in the office sector is displaying worrisome signs, with a spike in delinquency and default rates that hark back to the turbulent times witnessed in 2020's Q4.

Together with

Good morning. Rising delinquency rates in the office sector paint a grim outlook. Stefan Soloviev, known as Sheldon Solow's heir, is turning his focus on North Fork, NY. Meanwhile, Blackstone Group and Boston Properties just sold one of the largest deals in Washington, D.C. this year.

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Market Snapshot

S&P 500
GSPC
4,258.19
Pct Chg:
-0.1%
FTSE NAREIT
FNER
633.73
Pct Chg:
1.2%
10Y Treasury
TNX
4.719%
Pct Chg:
-0.3%
SOFR
1-month
5.32%
Pct Chg:
0.2%

*Data as of 10/06/2023 market close.

CMBS DELINQUENCIES

Office Loan Charge-Offs Soar as Lenders Grapple with Mounting Distress

This is an excerpt from Trepp's September 2023 Special Servicing Report

Strong sales since the worst of the pandemic convinced high-end retailers of the importance of brick-and-mortar locations.

Banks' lending to the office sector paints a concerning picture as delinquency and default rates rise, reminiscent of the 2020 Q4 figures.

The numbers: In September, the Trepp CMBS Special Servicing Rate notably rose to 6.87%, marking a continual increase since its drop to 5.11% earlier in the year. Particularly, the office sector witnessed a substantial hike of 62 basis points, exceeding the 8.00% threshold for the first time since May 2017. Concurrently, mixed-use rates also ascended by 26 basis points, while multifamily rates saw a 44 basis points decline.

Distressing downturn: Trepp's research from September 2023 paints a grim portrait of the office sector. Notably, net charge-offs and delinquency rates for commercial real estate (CRE) loans are on the rise. Alarmingly, the commercial mortgage origination volume for Q2 2023 plummeted to merely 60% compared to the pre-Covid 2019 averages.

Charge-off a cliff: Focusing on publicly accessible bank balance sheet loan-level data, Trepp unveils the startling magnitude of charge-offs. To clarify, a charge-off is an action wherein a bank foresees and registers imminent losses onto its balance sheet. Notably, these figures don't reflect in delinquency statistics since they're already accounted for. Astonishingly, the office sector's net charge-off value catapulted from $49 million in Q4 2022 to $149 million in Q1 2023, culminating in a staggering $459 million in Q2 2023.

Rate revelations: Calculating the net charge-off rate involves dividing the charge-off value by the entire loan balance, offering insights into the charge-offs' acceleration. Surprisingly, the lodging sector's charge-offs equaled those of the office domain. Trepp postulates that the lodging sector's traditionally smaller outstanding loan balance inflates its charge-off rate. Additionally, while the majority of property categories showed either steady figures or marginal reductions in outstanding balances between Q1 and Q2 2023, the multifamily sector recorded a noticeable spike in its bank loan balance.

➥ THE TAKEAWAY

Why it matters: Despite the observable data and troubling numbers, the real concern lies in the resurgence of delinquency and default rates, mirroring the troublesome times of 2020 Q4. As of Q2 2023, the total delinquency rate increased to 1.15%, and the serious delinquency rate reached 0.95%, highlighting potential challenges ahead for the office real estate market.

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Demand for multifamily housing is still high (especially in Texas) and supply isn’t catching up as new construction starts are falling. Multifamily construction starts are considerably down over the past two-year average.

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URBAN EMPIRE

Real Estate Tycoon Stefan Soloviev Eyes a Billion-Dollar Harvest in North Fork

Illustration of Stefan and Hayden Soloviev (Illustration by Kevin Rebong for The Real Deal)

Illustration of Stefan and Hayden Soloviev (Illustration by Kevin Rebong for The Real Deal)

Stefan Soloviev, previously best known as the heir to Sheldon Solow's empire of office and apartment buildings, is now turning his attention towards the North Fork of New York. Alongside his son Hayden, he's looking to capitalize on the agricultural and real estate opportunities available in this region, while also integrating it with his personal interests and past experiences.

The backstory: Stefan Soloviev is not a stranger to farming. Though an heir to an empire, he once traded luxury for a simpler life on the plains, creating a grain production business. Over time, speculation arose that Soloviev might dispose of his father's real estate portfolio to focus on ventures out West. However, with an increasing interest in the North Fork, he finds himself drawn back to the East, seeing it as a potential goldmine.

Family business: One of the driving forces behind Stefan's shift in focus is his son, Hayden Soloviev. As the Soloviev Group Vice Chairman, Hayden is being primed to head the company's Atlantic region, which includes North Fork and Shelter Island. Stefan envisions this region contributing a whopping $1 billion annually to the company in the near future. Family ties are strong for Stefan, as he often names his businesses and properties after his children and places great emphasis on working alongside them.

Challenges and opportunities: The North Fork, known for its agricultural roots, faces tensions with real estate developers. Locals are keen on preserving its essence, even setting up funds to prevent excessive development. Nevertheless, Stefan remains undeterred. He's expressed his intent to build homes and potentially a boutique hotel in the area, albeit facing some resistance from residents and pre-existing regulations.

➥ THE TAKEAWAY

New York ambitions: Returning to New York is not only about business for Stefan. It's a chance to reconcile with his past and perhaps embrace the legacy left by his father, with whom he shared a tumultuous relationship. Despite being passionate about farming, Stefan has significant ambitions in New York, pushing the occupancy of prime properties and even considering establishing the city's first casino. However, his primary passion remains clear: his wheat operation out West, which he aspires to grow exponentially.

AROUND THE WEB

📖 Read: NYC's affordable housing, supported by policies like the 2019 rent law, inadvertently promotes lower living conditions by restricting repair-related rent increases, potentially leading to future widespread property deterioration reminiscent of past housing crises.

🎧 Listen: Susan Miller Gruppi of M2G Ventures explores contemporary fundraising, Family Office trends, making industrial sectors appealing, and revitalizing Fort Worth stockyards in a podcast discussion with The FORT.

DEAL OF THE DAY

Blackstone and Boston Properties Close $305M Deal with Artemis Amid Tax Hike Sunset

Real estate giants Blackstone Group and Boston Properties have made a significant sale in Washington, D.C., offloading a large office property for $305 million to Artemis Real Estate Partners.

Deal details: The property in focus is Metropolitan Square located at 655 15th Street NW. Blackstone had an 80-percent stake, with Boston Properties owning the remainder. The property spans 654,000 square feet, translating to approximately $466 per square foot, potentially marking one of D.C.'s biggest property deals this year.

Between the lines: Boston Properties held a majority stake in the building since 1998, with Blackstone joining in 2016. Despite its premium status as the fourth-largest Class A office in the city and housing popular tenants like Old Ebbitt Grill, the property faced challenges. Occupancy dwindled to 58% by mid-2020 after the exit of two major tenants. To enhance its appeal, $60 million was invested between 2017 to 2020, focusing on modernizing the lobby, building mechanics, and amenity spaces.

➥ THE TAKEAWAY

Zoom out: The deal's timing leveraged a temporary tax benefit, saving around $6.5 million due to a sunset on hikes for transfer and recordation taxes in D.C. While this transaction is significant, both Blackstone and Boston Properties seem cautious about the office market's future, hinting at shifts in their investment strategies.

📈 CHART OF THE DAY

The U.S. 30-year fixed-rate mortgage has hit its peak since 2002, exacerbating housing affordability, now at a historical low, per the National Association of Realtors, amidst surging home prices and limited inventory. The graph above details the mortgage's trajectory since 2013 against home sales, using Freddie Mac and Trading Economics data.

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