Professor Glenn A. Okun
How do you lose money investing in triple-A-rated bonds? You just had to own bonds secured by the mortgage on 1740 Broadway in midtown Manhattan. These bonds generated a loss in excess of twenty-five percent, write-offs not seen since the Global Financial Crisis (“GFC”). While aggregate losses are expected to be lower than those incurred in the last debt crisis, the threat to investors remains.
Losses in the senior tranche of this commercial mortgage-backed security (“CMBS”) illustrates the extent of the distress in commercial real estate, especially office properties. Older buildings dominated by a single tenant are likely to be particularly vulnerable. These assets will trade at a small fraction of their booked value. 1740 Broadway, which was acquired by Blackstone in 2014 for $605 million, was sold in 2022 for $186 million.
Stress is not limited to office assets. Other local properties, including retail, that depend upon office tenants’ patronage have not been left unscathed. Barclays recently issued a warning regarding debt securities related to shopping malls in San Francisco and Nyack, New York.
There is more than $3.7 trillion dollars of commercial real estate securities and debt outstanding. Moody’s has estimated that 6.4% of the office loans packaged into CMBS are delinquent, the highest rate since 2018. KBRA has reported that 31% of office loans in commercial mortgage bonds, or $52 billion, were troubled as of March 2024. Regional exposures vary, with Chicago and Denver facing sixty-five to seventy-five percent of their office properties saddled with troubled loans.
The impending commercial real estate wreckage with its consequences for debt and equity investors will be notable. Regional economies may be affected by reduced lending capacity as banks work out troubled real estate assets. Regional and smaller banks remain unattractive and should be avoided as a result of the commercial real estate overhang.
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