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Hitting the "Wall of Maturities"

David Winzelberg 04.01.2016 | Long Island Business News

It's time to pay the piper.

That's what many owners of highly leveraged commercial properties are hearing these days, especially those who took securitized loans during the fast-and-loose borrowing times a decade ago.

When acquiring or refinancing commercial real estate prior to the Great Recession, a gaggle of property owners waded into the Commercial Mortgage-Backed Securities pool between 2005 and 2007 to take advantage of overly generous appraisals and loan-to-value ratios that sometimes eclipsed 90 percent.

But here we are 10 years later and, dubbed the 'wall of maturities,' those 10-year-term CMBS loans are coming due. Now many of those borrowers who've enjoyed interest-only securitized lending are facing huge balloon payments and some very tough choices: get foreclosed and walk away, put in more capital and refinance, or find new investors and give away equity.

Similar to the much larger subprime residential securitized lending that helped bring down a couple of the nation's biggest financial institutions, CMBS loans are packaged and sold to yield-hungry investors in tranches, with the riskiest loans offering the best returns. So even when the loans go bad the original lenders have little exposure, since it's the CMBS bondholders who are left holding the bag.

Epic fail

The losses so far are staggering. In Nassau and Suffolk counties alone, 28 CMBS loans have been resolved at a combined loss of $371 million in just the last three years. Those include a $41.8 million loan loss for the Long Island Marriott in Uniondale and a $73.6 million loan loss for the two-building Jericho Plaza office complex in Jericho.

And there's more to come. Between now and the end of next year, $192.2 billion of CMBS loans come due nationally, with $87.1 billion maturing this year and $105.8 billion in 2017, according to Trepp, a Manhattan-based firm that tracks the CMBS market. On Long Island there is more than $2.16 billion in CMBS loans for more than 170 properties coming due in the next 21 months.

Among those with impending maturities here are malls, shopping centers, big-box stores, hotels, multifamily complexes and office buildings, including some of the area's most notable business addresses.

"If the leverage on their current loans is too high or higher than what a bank or CMBS lender is willing to do, or if they've lost tenants or the value of their property has gone down, they are facing some challenges," said Joe McBride, a Trepp research associate.

Though many property types were overvalued by loan underwriters a decade ago, office and retail - the two property types with the largest representation in CMBS - face the greatest refinancing risk.

"We're going to see a transition in retail. I think strip centers are going to be fine because they have neighborhood retail like a CVS and a grocery store," McBride said. "But the big centers that have a JC Penney or a Sears or a Best Buy, they're all closing. If you could figure out a way to fill those empty big-box stores and make money off of it, you'd be the next billionaire."

Lost in space

And while big-box retail may be a weak spot, the worst-performing sector continues to be suburban office, where vacancy rates exceed those of every other commercial real estate category.

Compared with retail, industrial and multifamily properties, which have current vacancy rates between 4 and 9 percent, the Long Island office market finished 2015 with a 17.1 percent overall vacancy rate, according to Cushman & Wakefield.

"The office market is still very soft on Long Island. There's a huge differential between price and income stream," said Laureen Harris, partner of Cronin, Cronin, Harris & O'Brien and president of the Association for a Better Long Island. "That's a black hole in the Island's real estate economy."

Commercial real estate broker David Pennetta of Cushman & Wakefield said lenders are forcing office-owning borrowers to keep larger reserves from their cash flows, reducing their net operating income even further. As a result, some are doing strategic defaults, putting their money in other properties that are also coming on the market.

"Investors are always looking for the best return for every dollar," Pennetta said. "The best investment might not be to hold onto the property you already have."

Hold 'em or fold 'em

Knowing when to hold and when to fold is top of mind at RXR Realty, which controls Long Island office properties financed with more than $500 million in CMBS loans coming due within the next 11 months.

In the case of three office buildings in Melville known as Reckson Portfolio II, they were returned to the lender last year at a loan loss of more than $18.7 million. Scott Rechler, CEO of RXR Realty, which was managing the properties, said the trio of largely vacant buildings was owned by one of the firm's real estate investment trusts.

"Because it's a publicly traded REIT, we didn't have money to put in," Rechler said. "It was 70 percent owned by public shareholders in Australia, so we can't write a check ourselves."

However, RXR decided to hold onto its sprawling 28-property Woodbury portfolio, which it managed to refinance in 2014 after securing a $144 million loan from an affiliate of Manhattan-based NorthStar Realty Finance. The loan refinanced two CMBS loans written in 2005 that had a balance of $219.4 million, according to Trepp, which were resolved with a $79.4 million loss. The Woodbury portfolio is a prime example of RXR's ongoing loan-to-own strategy. RXR took control of the properties after providing $28.4 million in mezzanine financing and taking title in a deed-in-lieu of foreclosure deal. White Plains-based Houlihan-Parnes and CLK Management had purchased the portfolio for $355 million in 2005, but defaulted on their CMBS loan in 2010.

Triple witching hour

"We always knew that come 2015 through 2017 there was going to be a round of loans that are going to be maturing, loans that were done in '06, '07 and '08," Rechler told LIBN. "But that's happening at the exact time that the CMBS market itself is going through a liquidity challenge because of new accounting rules and regulatory issues where they have to retain a certain percentage of every loan they make. So the CMBS market is going to be down 40 percent this year in terms of the amount of issuance. Couple that with banks being warned by regulators to manage their real estate exposure - you have the lending environment contracting at the same time that you have all these loans coming due. You can even call it the triple witching hour because you have the bubble of all those loans maturing, you have the CMBS market contracting and you have the banks being forced to lend less."

Escape from suburbia

RXR and its institutional partners, along with other large property investors, have been re-evaluating their stakes in suburban office buildings in the last few years. Rechler said there are challenges with suburban office space because "there's just not a lot of institutional capital that wants to support it," so the company has redirected its recent investments, which since 2009 have been spent on properties in Manhattan.

"I think there's a bifurcation in suburban office," Rechler said. "We're doing very well in RXR Plaza - that's more than 90 percent leased. The Omni is 90 percent leased, so those two buildings there are doing well. In New Jersey, we have the Short Hills Office Center, where we're getting more than $50 a foot in rent. I think when you go off those key corridors, that's where it starts to fall off and the office space becomes much more commodity-like, and you don't have pricing power and it's hard to get occupancy. It may be at a point where there's competitive obsolescence and you have to rethink how those properties are used."

With institutional investors seeking to shed their interests in suburban office, there's now a plethora of Long Island office buildings for sale or about to hit the market. They include the two-building, 400,000-square-foot 3 Huntington Quadrangle in Melville; the four-building, 152,500-square-foot Expressway Plaza in Roslyn; the 672,000-square-foot, two-building Gateway at Lake Success complex; the 247,000-square-foot 900 Stewart Ave. in Garden City and its sister building, the 207,000-square-foot 990 Stewart Ave.; and the 68,500-square-foot building at 200 Broadhollow Road in Melville.

"This is the most suburban office product on the market we've seen in 10 years," said Adam Rochlin, principal of the Jericho-based Rochlin Organization.

Rochlin said suburban office is beginning a transition from institutional ownership back to local ownership, which should shorten the deal cycle when it comes to leasing.

"It takes an average of six to eight months to broker a lease with institutional owners, where it used to be three months with local ownership," Rochlin said. "That's because they are more efficient and have the ability to make quicker decisions. They have architects and attorneys in-house and it's not decision by committee; they don't have to bid out work."

Picking up the pieces

Meanwhile, mortgage brokers on the front lines of the refinancing battles say the so-called 'wall of maturities' is creating opportunities for the area's community banks and credit unions seeking to scoop up more commercial real estate financing business.

Jake Handelsman, managing director for Eastern Union Funding's Long Island office in Valley Stream, said "a lot of these deals are being snatched up by banks and credit unions." He named Bethpage Federal Credit Union, Suffolk County National Bank, Empire Bank and Gold Coast Bank as lenders that have been actively taking over maturing CMBS loans.

"What I'm structuring for these CMBS borrowers coming due is a finance structure where they're not cashing out their money on the refinance, instead they're getting their money from the property income via getting an interest-only period," Handelsman said.

Commercial mortgage broker Jonathan Goldman, of Jericho-based M. Robert Goldman & Co., said the most important thing in underwriting property is the income and the reliability of that income. He added that CMBS is becoming the financing of last resort.

"CMBS right now is expensive. It's where you go if you can't get a loan from a traditional lending institution," Goldman said. "CMBS rates are over 5 percent. We're doing deals under 4 percent and insurance companies are giving 3.5 to 4 percent for comparative 10-year deals."
And though the investment world is desperate for yield, Goldman says capital is very picky.

"The stuff that was really bad was already foreclosed," he said, "and the good stuff has already been refinanced. There's too much money chasing too few deals."

A taxing situation

The only out for those property owners up against the CMBS maturity squeeze who can't add equity partners or scrape up enough cash to facilitate refinancing is to give the building back to the lender. But even that scenario has some painful consequences.

"There's a cost to giving the keys back," said Meyer Mintz, tax partner for Berdon's real estate group. "If I give the building back to the bank, the government said I made money. It can cost you millions in taxes."

The risk for potential tax liability was echoed by Jed Dallek, a partner of Gettry Marcus CPA in Woodbury.

"There is no cancellation of debt," Dallek said. "The gain or loss will equal the outstanding balance of the debt less the tax basis of the property. If the property is an investment property, the gain will be a capital gain."

The fallout

While impending CMBS maturities and the related credit crunch may be putting the squeeze on heavily leveraged property owners, industry insiders say the situation won't have a crippling effect on Long Island's commercial real estate market.

"I think the CMBS maturities will be neutral to the market as far as fundamentals," Goldman said.
Mintz agreed. "I don't see it having much of an effect on the overall market," he said. "We will see more properties coming available."

Handelsman also foresees more real estate changing hands.

"I believe there's going to be a lot of product coming to the market for what the amount of the debt is, which represents a significant discount," he said. "Borrowers would rather sell the property at a discount and pay off the loan than have to return the property to the lender and tarnish their name."

Harris says the CMBS bubble won't be as prolific as the residential subprime debacle.

"The commercial market is a lot more sophisticated so it's a little different dance and it won't surprise the market," she said. "It's become a lesson in economic history."

Trepp's McBride said it's less about a macro Long Island thing, because the area's demographics and its proximity to New York City bode well.

"It's a good market, but what's not good right now is suburban office, big-box retail and big malls, those types of things, and there's a lot of that on Long Island," McBride said. "The overall market should be fine, but I think those particular sectors have trouble ahead, both on Long Island and everywhere."

Berdon LLP, New York Accountants