A look at what will happen next in the world economies
Monday, June 13, 2016
Now Coming to the Commercial-Property Market: Defaults
It is fascinating to watch how the cycle of overbuilding continues. Aivars Lode
New signs of weakness emerging; ‘There’s going to be a correction’
By Eliot Brown
For nearly a decade, the 14-story Houston office building called Northborough Tower proved a reliable investment for fund manager Behringer Harvard, staying fully leased and generating millions in profit.
But now the gleaming building is being surrendered to creditors. Its $21 million mortgage came due in January, and Behringer Harvard wasn’t able to find buyers willing to pay more than that. At the same time, its only tenant is leaving and the Houston office market is reeling from low oil prices.
“We received no offers above the debt balance,” said Thomas Kennedy, president of the Behringer Harvard fund that bought the building for $33 million in 2007.
New signs of weakness are surfacing in the commercial-property market, ending a half-decade run of improvement with steadily climbing values. Amid global shifts like the sluggish Chinese economy and a new era of low oil prices, defaults on loans are popping up in areas that were considered overheated, occurring in small numbers for now, but stoking fears that more could be on the way.
This comes as there is a growing view that the best days are in the past for this property cycle, which benefited strongly from low interest rates and demand by global investors from regions like China and oil-dependent economies in the Middle East.
“We’re at the top of the market,” said Kenneth Riggs, president of Situs RERC, a real-estate research firm that advises investors on property values and market direction. “There’s going to be a market correction.”
If there is a downturn, few expect it to be severe because the economy is still creating a healthy level of jobs and lending has been far less aggressive than in past booms like 2007, when highly leveraged developers defaulted as the market slowed. Developers back then were routinely able to secure debt for more than 90% of the value of a building, compared with less than 80% today.
Any correction now, Mr. Riggs said, will be “let’s call it, manageable.”
Still, there are several pockets of concern.
The Northborough Tower is one of numerous office buildings in which debt is coming due in the Houston area, where the amount of office space vacant or soon to be available for lease was 23% at the end of 2015, up from 17.8% a year earlier, according to real-estate services firm Savills Studley. With vacancy expected to rise further still, investors are staying away from the area and lenders have grown particularly wary.
Worse yet are the oil-drilling boomtowns in west Texas and North Dakota, where apartment rents have plunged thanks to a growing level of new supply hitting the market at the same time that low oil prices have sapped demand.
A similar effect can be seen in New York, where the condominium market aimed at the superrich has slowed just as a wave of towers are hitting the market.
“The for-sale condo business has dramatically slowed at all price points and in all neighborhoods,” said Steven Roth, chief executive of Vornado Realty Trust, during an earnings call last month. The company is building a 950-foot condo tower on Central Park South.
In turn, lenders have eschewed the sector, leaving developers who paid high prices for land unable to pay off their debts.
Such is the case for the Bauhaus Group, a developer that had planned a slim, tall condo tower on Manhattan’s East Side but is now fighting in court with lenders seeking to foreclose after the owner didn’t repay $147 million in debt.
Another developer, Ian Bruce Eichner, is facing a similar attempt to seize his site in Harlem, where he had planned a 680-apartment rental project.
A spokesman for Mr. Eichner has previously said the capital markets have retrenched and the timing is unfortunate. The developer has been seen as something of a canary in the coal mine. He was among the early, high-profile defaults in 2008, when he lost control of a $4 billion Las Vegas casino project.
Meanwhile, loans are becoming harder to secure even for safe investments such as well-leased buildings. That is because broader market volatility has caused lenders who sell off their loans via bonds known as commercial mortgage-backed securities to grow wary. While the segment made about $100 billion in loans last year, it has come to a virtual halt today, lending executives said. If that continues, it will become more difficult for landlords who took out 10-year loans in 2006 to refinance today.
The pullback might bring back business for so-called workout specialists, who help landlords escape foreclosure by modifying their debt.
With more debt coming due and other conditions, defaults are bound to increase, said Robert Verrone, a veteran lender whose Iron Hound Management Co. also helps borrowers modify troubled mortgages.
“The amount of inbound phone calls has definitely increased,” he said.