Sternlicht's dry "POW POW", long recession expectations, rising interest rates, and office vacancies
Welcome to our distressed debt newsletter.
This week we brace for impact as the Bank of England confirms the UK recession as being their longest on record, which we should assume does not bode well as an indicator for a quick US economic recovery. And while some may start to feel anxious as winter approaches, Starwood's Barry Sternlicht (aka the "Smart Money") prepares to "shred" some distressed opportunities by raising some serious dry powder- to the tune of $1.3 Billion.
Xchange.Loans has been very busy at packed special servicing/distressed debt conferences, meanwhile, our phones are ringing off the hook with new lender clients looking to exchange their loans for liquidity and from investors flush with cash-seeking opportunities. We seem to be at a great inflection point in the marketplace.
There is plenty of investor capital, demand, an increasing supply of distressed debt opportunities and a rapidly increasing demand for diversification of liquidity sources. The proverbial floodgates have not opened yet. This is why we STRONGLY recommend the disposition of special-purpose distressed loans asap.
Featured Article:
From gas stations and quick-serve restaurants to nursing homes, hotels and athletic clubs, special-purpose properties can be great commercial real estate (CRE) loan prospects. That is, unless the business falls apart. Once that happens, foreclosure on the real estate that’s an inherent part of the business is often a costly and risky move for the CRE mortgage lender. A better solution is to sell the note—and sell it early.
If you’re the CRE lender, the combination of issues equals a colossal headache and mounting costs. A receivership can lighten the load of managing the property, processing payments, handling repairs, selecting and overseeing contractors and more.
Unfortunately, the receiver can’t remove the legal and financial risks that you assume in the foreclosure-to-REO process. Even with a third-party manager, you’re still engaged with a business that was already failing for one reason or another. That puts your institution at risk of liability for liens, negligence, environmental contamination, and more. On top of that, you face continuing labor costs to keep the business operating.
Top 5 Distressed Stories:
Barry Sternlicht assured investors that Starwood Property Trust is being extra careful as it seeks opportunities amid economic turmoil. “It’s something of a financial hurricane,” he said during the REIT’s third-quarter earnings call on Wednesday. “You really can’t cure this inflation, which has been driven by excess stimulus and lack of goods on the shelves.” Sternlicht and other Starwood executives touted the strength of the firm’s portfolio and a $600 million, five-year loan it’s closing on this week. Jeff DiModica, the chief financial officer, said the loan gives the REIT $1.3 billion in dry powder — “the most liquidity we have ever reported.” “It is the best investing market that we’ve seen since 2009, with the banks on the sideline, and many of our public mortgage REIT friends recently taking write-offs and taking write-downs,” Sternlicht said.
The Bank of England has warned the UK is facing its longest recession since records began, as it raised interest rates by the most in 33 years. It warned the UK would face a "very challenging" two-year slump with unemployment nearly doubling by 2025. Bank boss Andrew Bailey warned of a "tough road ahead" for UK households, but said it had to act forcefully now or things "will be worse later on". It lifted interest rates to 3% from 2.25%, the biggest jump since 1989. By raising rates, the Bank is trying to bring down soaring prices as the cost of living rises at the fastest rate in 40 years.
Between 1997 and the end of 2021, effective office rents, which factor in free months of rent and other gifts to tenants, in the 50 biggest U.S. markets fell by 16%, adjusted for inflation, according to data from Moody’s Analytics. And yet office-building values rose by an inflation-adjusted 91% during that period. Cheap debt fueled a decadelong boom in U.S. office values, offsetting the impact of years of rent increases that didn’t keep pace with inflation. Now that the long period of easy credit is over, office-building owners are bracing to see how much less their properties are actually worth. The prices of some ageing office towers in places such as New York and Chicago have already fallen by about a quarter as potential buyers struggle to land financing with interest rates rising fast, brokers and lenders say. Defaults are starting to move up from low levels.
Inflation has been running red hot in 2022. The Consumer Price Index (CPI) rose 0.4% in September on a seasonally-adjusted basis, which amounts to an 8.2% year-over-year increase since September 2021 before seasonal adjustment. The sharpest increases have been in the shelter, food, and medical care indexes. The 4.9% decrease in the gasoline index provided welcome relief at the pump, but was not enough to offset the increases in the other indices. At the same time, the Federal Reserve is doing its best to cool off the economy without pushing the country (and, the world) into recession — the mythical “soft landing.” In 2022, the Federal Reserve has already raised the federal funds rate five times for a total of 300 bps. The last three increases have been 75 bps each. This comes after nearly two years of the Federal Funds Rate hovering around 0%.
Hybrid work drives flight to quality, and tenants look to avoid long-term leases. Demand for office space around the United States has softened the past year, with average asking rents dropping and vacancies spiking in many markets. A new report from CommercialEdge found the average asking rent was $37.67 per square foot in September, down 2.4 percent year-over-year, and the national vacancy rate was 16.6 percent, 180 basis points higher than in September 2021. CommercialEdge estimates that 139.1 million square feet of new office supply are currently under construction around the country. But since the COVID-19 outbreak began, the geographic composition of new office construction has shifted, with gateway markets recording the largest declines.
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Top 5 Distressed CRE Stories:
The 129-year-old building at 19 S. LaSalle St. could be a candidate for conversion to a residential or other use as the city tries to bring more foot traffic to the heart of the Loop. The owner of a vintage 16-story office building on LaSalle Street is facing a $21 million foreclosure lawsuit, adding to a wave of distress on the historic-but-vacancy-ridden thoroughfare and teeing up a potential conversion of the property into a residential or other use. The building's occupancy dropped to 56% last year, when it generated just under $147,000 in net operating income, according to Bloomberg loan data. That was a fraction of Espinoza's $1.1 million debt service payment for 2021. The property was just 43% leased as of June when it was appraised at $13.3 million, Bloomberg loan data shows.
Simon Property Group and fellow investors reportedly have completed the transfer of the Crystal Mall to lenders, rather than pay off $81 million due on a commercial mortgage secured by the Waterford mall. The town of Waterford last appraised the mall at just under $60 million — about $8 million below the cost to replace the structure, not including department store anchor pads and standalone restaurants. But Trepp reported last year that the mall's value had plunged 88 percent to below $19 million, one of the five steepest drops nationally for retail properties. In 2015, the Crystal Mall got fresh regional competition east of the Connecticut River in the Tanger Outlets Foxwoods, less than a 30-minute drive away at the Foxwoods Resort Casino. And many shoppers have been gravitating toward open-air shopping centers like the Waterford Commons opposite the Crystal Mall, though Connecticut malls have continued to expand their offerings to compete with entertainment venues, restaurants and events.
The AES power plant site is in foreclosure, with more than $36 million in past due payments. Site owner Leo Pustilnikov describes the Oct. 21 Los Angeles County issuance as a “negotiation of a true-up over accounting,” stemming from state payments to keep the plant on standby.
The Los Angeles County Recorder’s Office sent a “Notice of Default and Election to Sell Under Deed of Trust” to Pustilnikov and the site’s other investors, stating that “Your Property is in foreclosure because you are behind in your payments; it may be sold without any court action.” “AES and I have an ongoing dispute over public payments,” said Pustilnikov. “Balances between what AES owes me and what I owe AES. It should be resolved in the next couple of weeks.”
By law, the county may not set a sale date within 90 days of the Oct. 21 notice of default. The balances in question, Pustilnikov explained, relates to California’s three-year extension for the AES plant to be kept on standby. It was originally scheduled to close in 2020. California pays AES to keep the plant operational, if not producing at limited capacity. When Pustilnikov bought the site in 2020, it was under a one-year extension with the state. “It’s merely a dispute between what AES owes me for the extension and what I owe due to how the extensions were procured as a one + two instead of a straight three-year,” Pustilnikov said.
“It’s literally a negotiation of a true-up over accounting.” AES declined to comment on the foreclosure notice, as did District Two Redondo Beach City Councilman Todd Loewenstein and District Three councilman Christian Horvath, citing related litigation between the city and Pustilnikov – a lawsuit by the city against the state for the plant extensions.
Pustilnikov and investors have a “lease-back” agreement with AES. Total past due payments alleged are $36,708,314.61.
Gamma FL Wynwood LLC, in care of New York-based Gamma Real Estate, won the foreclosure auction in September against New York-based Wynwood Gateway II LLC based on a $23 million mortgage, plus interest and fees. The lender submitted the high bid of $250,100 at the Oct. 17 foreclosure auction by utilizing credit from its judgment. That means ownership of the 27,650-square-foot property, at 166 and 179 N.W. 29th St., plus 169 and 179 N.W. 28th St., will transfer to Gamma FL Wynwood. The site is mostly vacant but does have a four-unit apartment complex. In 2021, the owner of the property submitted plans for a co-living project branded by the Collective. It would have had 108 apartments, 70 hotel rooms and 9,508 square feet of commercial space in 12 stories. However, the construction never began.
Onni Group has acquired a distressed Southern California outdoor shopping center for $103 million after taking ownership of the defaulted loan on the property, Commercial Observer has learned. The developer purchased The Paseo in Pasadena, Calif., via a deed-in-lieu, after simultaneously acquiring the property’s defaulted debt from Granite Point Mortgage Trust. The mall, which was built by The Hahn Company in 1980, lost both its anchor tenants back in 2013 when Macy’s and Gelson’s Markets closed. Today, the property’s major tenants include H&M, Tommy Bahama, Equinox, DSW and West Elm along with restaurant operators P.F. Chang’s, Tokyo Wako and Yard House. The property houses a newly completed Hyatt Place Hotel located where the Macy’s used to be.
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Michael Jimenez is a CRE Finance and NPL expert with 15+ years of experience, as well as the Founder and CXO of Xchange.Loans.
Xchange.Loans is a secure loan sale marketplace where CRE lenders can Buy. Sell. Value. commercial loans and NPLs with NO seller fees.