The unraveling: Distress in the market — and what to do about it
- July 1, 2023: Vol. 10, Number 7

The unraveling: Distress in the market — and what to do about it

by Geoffrey Dohrmann

Like many of you, I’ve been wondering when the long bull market in commercial real estate finally would begin to unravel. Well, the signs of distress are all around us now. Check out the following news stories:

  • On Jan. 25, GlobeSt reported that the largest owner of apartments in San Francisco, a joint venture between Veritas Investments and Baupost Group, had defaulted on a $448 million CMBS loan secured by 62 properties encompassing more than 1,700 units.
  • On Feb. 16, Commercial Observer reported that a $270.3 million CMBS loan on Blackstone’s Manhattan 11-property multifamily portfolio had been sent to special servicing.
  • On March 8, Commercial Observer ran another story noting that in the depth of winter, Brookfield — the largest office owner in Downtown Los Angeles — defaulted on major property holdings worth a combined $784 million. “Within days,” the Observer reported, “the defaults started coming fast and furious by some of the most respected and most-well capitalized names in commercial real estate, including Blackstone and Columbia Property Trust.”
  • On April 11, Institutional Real Estate Newsline reported the announcement that Blackstone had completed raising $30.4 billion for its latest global real estate fund, Blackstone Real Estate Partners X.
  • On April 11, Wolf Street posted a story on another default on four class B and class C apartment complexes, all built before 1981, with 3,200 units located in the Houston area. The apartments were sold at a foreclosure auction for $196.5 million by the lender, Arbor Realty Trust, which had $229 million in debt on the properties.
  • On May 3, a story appearing in The Registry announced Starwood Capital Group was putting up for sale a $293 million loan on a 720,000-square-foot office complex in Renton, Wash., that had recently been returned to the lender by the borrower, which had been in default.

The total defaults described above amounted to more than $2 billion and most likely are only the beginning. When you first notice a run of defaults and foreclosures, it’s a little like finding a cockroach in your kitchen. If you can see one, there are undoubtedly millions hiding behind the woodwork.

I’m personally invested in a few real estate investment programs myself, and recently for the first time received a capital call from one amounting to 10 percent of my equity commitment. The reason? Spiking interest rates had stressed the property’s ability to meet its construction loan commitments. The changing dynamics considerably reduced the total return prospects for this project, although the project technically isn’t underwater — yet.

All of the above defaults were related to a rising interest-rate environment. Many of them involved one of the remaining preferred property types: multifamily. Almost all of them involved private investors versus bank loans.

But the recent collapse of Silicon Valley Bank and First Republic Bank suggests many regional and perhaps even some large national banks may have been too aggressive in putting out loans during the recent prolonged low interest-rate environment. Now that rates are rising at the same time that many tenants are reducing their footprints, there no longer is sufficient cash flow to cover the debt.

Of course, all this turmoil creates pricing opportunities for those with cash to burn. The problem for those of an opportunistic bent is that it is still difficult to price these troubled assets. Transaction volume has slowed down, and it is still unclear what the future bodes regarding occupancy and rent growth (or lack thereof). Debt capital to finance these kinds of transactions also is becoming scarce.

Then there’s Blackstone’s Fund X announcement. In every real estate cycle, someone has to be the one to top the market, in terms of the largest-ever capital fundraise. This might have been it. It is interesting to note that Blackstone’s historic fundraise was announced sandwiched between stories of total defaults amounting to as much as $823 million in investor equity. It’s also interesting to note that, in almost all of these cases, the ones holding the bag on these defaults were large, sophisticated investment managers or REITs with solid balance sheets and long track records.

It’s always been our policy not to wash the industry’s dirty linen in public. And we’re not calling out specific players here — only noting some of the more visible stories that have appeared in the papers and online news outlets recently. We’re sure these stories — like cockroaches — are a lot more plentiful than the ones we can see in the kitchen right now.

As I’ve written here before, what’s needed is a national — perhaps even a global — database of commercial and residential real estate loans. Not only should borrowers and lenders be required to file relevant closing documents, but borrowers also should be required to provide quarterly financial updates on the health of their own financial situation and on the financial health and performance of their properties. This would provide real estate analysts and regulators with the information they need to properly monitor and evaluate the conditions of the markets.

The same is needed to help govern the derivatives markets. Investors accessing these markets must be reassured that they fully understand the counterparty risks they are assuming; otherwise, their confidence in these markets to hedge their risks will continue to be severely undermined.

This is not very laissez-faire of me, I know. But the risk of another global financial market meltdown is very real, and the consequences of that meltdown if it can’t be stopped are too terrible to contemplate. Sometimes trade-offs need to be made. Giving up a little free-market leeway in exchange for greater global financial security certainly seems to be a worthwhile trade-off.

Do I think any of this really will happen? Probably not.

Whatever the industry and regulators decide to do, however, it’s important that they be careful. They need to be very, very careful. It’s a wacky world out there.


Geoffrey Dohrmann is president and CEO, publisher and editor-in-chief of Institutional Real Estate Inc., parent company to Real Assets Adviser.

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