Lockdowns loosen in New York and other major cities, but commercial real estate remains tied

The assessment of the coronavirus pandemic on the estimates $ 16 trillion US commercial real estate market has only started to show up as buildings begin to reopen in major cities and properties emerge from months of massive closures.

New York City embarked on Monday on phase 2 reopening, which means restaurants and bars may start offering outdoor seating only, some in-store retail may resume, as well as visits to salons, hair salons, car dealerships and Moreover.

But under the guise of the new normal, tenants are battling landlords for rent relief, a deluge of homeowners behind on their mortgages and tumbling home prices.

Where it all ends is a guess. Much will depend on which parts are relieved and whether house prices continue to fall. The trajectory of new infections and the reaction of consumers to the reopening of more and more real estate in the United States will also be major factors.

Coronavirus Update: US death toll nears 120,000, with 24 states showing increasing case count trends

“I think it’s going to be a hailstorm over there,” said Jeffrey Citron, co-managing director of law firm Davidoff Hutcher & Citron LLP. “And I think in most cases it’s probably in the best interest of landlords to sit down and work with their tenants.”

Citron’s law firm represents Victoria’s Secret Stores, part of L Brands US: LB
, who earlier this month filed a monthly demand for rent relief of nearly $ 1 million against owner SL Green for his Herald Square store in Manhattan. The tenant, arguing in a court case, believes his lease on the property should be terminated, in part because of the unprecedented “pause” that befell New York as authorities tackle the global health crisis, but also because “the experience buying consumer goods in a retail store has been forever changed.

SL Green legal counsel Stephen Meister said in a statement that the landlord had made several representations to the tenant with “offers to defer part of his rent at 2 Herald Square”, but that the “large listed national conglomerate The stock market exploits the current health and economic crisis for its own financial gain rather than honoring its contractual rent obligations.

SL Green is one of New York City’s largest office owners. In June, he reported improvement in rent collection in April at 95.1% for offices and 63.3% for retail, against an initial count for the month at 91.8%, 60.0%, respectively.

The high-profile dispute is an example of the uproar in U.S. commercial real estate, particularly over who pays what bills, how much, and when, over properties often designed to withstand earthquakes and other natural disasters, but not necessarily viral outbreaks. deadly.

“A lot of tenant companies analyze their leases and try to renegotiate, either for less rent, or for less space, or even to terminate their lease,” said William O’Connor, partner at Thompson & Knight LLC, specialist In the real estate. workouts.

“Some tenants are willing to make a lump sum payment and move on,” O’Connor told MarketWatch, adding that several landlords had offered free rent to businesses wishing to sign 10-year leases.

“This matches the type of debt they would take on,” he said, pointing to the 10-year term of many US commercial real estate loans.

The American Dow Jones DJUSRE real estate index,
-0.56%,
which tracks U.S. real estate investment trusts, was down 14.7% year-on-year as of Monday, while the largest Dow Jones Industrial Average DJIA,
-0.75%
was down about 9% over the same period.

Distressed regional shopping centers have been on a downward financial spiral for years, with JCPenney Co. Inc. FROM: JCP
, Macy’s Inc. M,
-7.12%
and other retailers are closing their stores left and right to make up for the drop in sales. COVID-19 has only made their problems worse, placing retail businesses and hotels at the top of the list of types of American properties seeking debt relief.

In June, the default rate on all commercial real estate loans bundled into commercial mortgage-backed securities reached 10%, matching its previous peak during the global financial crisis more than a decade ago, analysts at Goldman Sachs, who expect CMBS defaults to hit. a record 11.3% in July.

Banks, insurance companies, private equity funds and other lenders also finance commercial real estate, although often without the same level of transparency as in the CMBS market, where loans are turned into bond transactions. , and investors see monthly property performance reports that signal potential issues.

Many of the largest real estate finance deals in the United States of the past decade have taken place in the CMBS market, in part because large loans can be split into several different bond deals. But when credit nearly dried up overnight in March, it made lenders and bond investors more cautious, and new CMBS volumes have fallen 25% to $ 32 billion since the start of the market. year, compared to the same period last year, according to data from Deutsche Bank.

“It’s next to impossible to take out a loan where you have no idea what future occupancy rates will be and what the net operating income will look like,” said Courtney Statfeld, director of McKool Smith, a firm lawyers specializing in real estate disputes.

“We work with a number of struggling debt funds, and they certainly have an appetite, but they’re holding on and watching,” she told MarketWatch.

Another concern is that many borrowers with commercial properties, from luxury beachfront hotels to sparkling office towers, have cashed in equity when their properties were last mortgaged, over. the basis of real estate values ​​going in one direction: on the rise.

Borrowers are considered to be at a higher risk of default when they have little or no equity in a property, especially when prices fall and leave them underwater on their debts.

The last of Green Street Commercial Property Price Index shows that after hitting a record high in January, house prices have since plunged 11% year-to-date in May.

“One of the hardest things to do right now is to determine the value,” O’Connor said, adding that his customers expect there to be more clarity on the damage from COVID- 19 as the fourth quarter approaches. But O’Connor also said his clients were bracing for at least a 15% drop in house prices.

Gina Szymanski, portfolio manager in AEW Capital Management’s real estate securities group, believes the future is generally less bleak for commercial properties, especially as industrial centers and other e-commerce-oriented properties have experienced a commercial boom in the last three months of closure. . She also sees some tenants as “opportunistic just because they can” and use rent as a bargaining tool.

That said, Szymanski remains cautious about heavily discounted real estate sectors, especially when future cash flows appear uncertain and buildings will likely operate “below an ideal level” of capacity.

“I think the key is to assess the strength of the balance sheet of these companies,” she told MarketWatch. “And make sure you don’t catch a falling knife.”

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