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Interest Rates Crash Commercial Real Estate’s Covid Recovery

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452 Fifth Avenue (Wikipedia, iStock, Illustration by Siamonahan of Real Deal)

In early December, Andrew Chung’s Innovo Property Group signed a deal to wire deposits and buy a 30-story HSBC anchored office tower overlooking Bryant Park for $ 855 million.

When Chung worked to sign a deal on 452 Fifth Avenue, it made him Fragmented industrial builder The Federal Reserve has signaled the landlord of the Midtown office to raise interest rates to combat inflation. By May, the SOFR rate (a rough estimate of the cost of borrowing a bank) soared from near zero in mid-March to 0.78 percent.

5 months later Chung has passed the deadline Closed the tower and lost him $ 35 million deposit..

There were various challenges in trading, but Mr. Chung struggled to raise stock from the beginning and placed a bet by depositing his first deposit, but rising interest rates certainly complicated the matter. did. Chung had to fork more and more money to secure his money. Innovo did not respond to your request for comment.

The public collapse of Mr. Chung’s deal with the HSBC Tower has nailed the city’s commercial real estate community and heightened concerns about rising interest rates.

“We definitely think it’s a good time to be the second best bidder in a deal.”

— Slate Property Group, David Schwartz

It’s the biggest deal that has collapsed since interest rates began to skyrocket earlier this year, but it’s not the only one. Buyers, sellers and owners in the city Interest rate environment What many young professionals have never seen in their lifetime.

In June, the Fed raised interest rates by 75 basis points. This is the largest increase since 1994.Economists Similar hikes Continues in July and September.

Higher rates mean that funding will be more expensive. That is, real estate owners need to withdraw more money from the building to cover their costs. At the very least, it makes sales more complicated and all sides are changing things on the fly.

Andrew Sasson, Ackman-Ziff’s broker, said: “The lender is retrading the pricing to the borrower in the middle of the transaction.”

Big cold

Transactions slowed down as prices went up.

According to MSCI Real Assets, national commercial real estate sales fell 16% annually to $ 39.4 billion in April, the first decline in more than a year.

A wave of office debt that matures will further test the market, as owners may find that they can’t borrow as much as they used to to pay off their loans.

According to Trepp, over $ 7 billion in CMBS office loans in New York will mature more than the sum for the last three years.

Trepp’s Manus Clancy said in a recent podcast that higher borrowing costs are likely to put pressure on owners who have little buffer to cover debt repayment costs. In such cases, the owner may have to invest capital in the transaction when refinancing.

“At that point, it will probably be cash-in,” he said.

Refinancing options are not only more expensive, but more restrictive for real estate owners with debt that is maturing.In addition to rising interest rates, the CMBS market Retreat in recent months Inflationary concerns and instability in Ukraine.

“The CMBS market isn’t working very well,” SL Green Realty President Andrew Matthias said at the June Nalight Conference. “Not many cash buyers of Triple A bonds.”

As CMBS is declining, borrowers must instead rely on banks and debt funds for refinancing and new acquisitions. But even debt funds, which rely heavily on credit lines known as warehousing loans, are inextricably linked to interest rate fluctuations.

“If you are buying stable real estate with a tight cap [rate]It’s difficult to raise money, “said Ian Ross, founder of Manhattan-based development company Somera Road.

Rate cap

Borrowers have protection against rising interest rates, but they are also more expensive.

One such protection, the interest rate cap, has seen its price rise tenfold in the last few months.

Lenders require most borrowers to protect against unexpected rate increases by purchasing rate caps that the counterparty agrees to pay the borrower when interest rates exceed a certain point. ..

Six months ago, a two-year cap on a $ 50 million loan cost the borrower $ 85,000, according to Risk Management Advisory Chatham Financial. The limit is currently $ 893,000.

“The rounding error has cost us a lot,” said Chris Moore, a member of Chatham’s real estate team.

Moore said the volatility of the commercial bond market will continue to reach price limits. Also, as with interest rate fluctuations, the uncertainty of the maximum amount between the time the buyer signs the contract and the time it is ready to close the transaction is another factor that the borrower should consider.

“It adds an additional layer of uncertainty and a potentially higher cost to underwriting,” he said.

There is no safe shelter

Sellers may find that the interest rate environment justifies a more conservative approach.

David Ash, founder of Prince Realty Advisors, said owners may consider making more direct transactions rather than a formal marketing process.

“I’m more interested in doing things quietly, directly with people who know they can work and get intimate with them,” he said.

In April, Vornado Realty Trust signed a direct contract to sell an office property in the Center Building in Long Island City to 60 guilders. $ 173 million.. Jared Toothman of Vornado and Kevin Chisholm of 60 Guilders negotiated at the supper.

It’s clear that rising interest rates make things difficult for buyers and sellers, but holding them doesn’t prevent the problem.

After Chung’s contract to buy the HSBC Tower collapsed, its owner, Eli Elefant’s Property and Building Corp., had to refinance the property because the existing loan had expired. PBC eventually paid a high rate of 3.9%. This is a penalty for virtually not selling.

Sasson of Ackman-Ziff said there was no place for sellers to hide.

“The alternative is to borrow safe funding, and the funding market has changed,” he said. “You either get tired of the value when you sell, or you get tired of the interest rates when you go to finance it.”

Pain play

Some believe that rising interest rates may open up new opportunities as more transactions collapse.

In some of these cases, the highest bidder in the transaction may not be able to complete the financing, and the bidder with the smaller offer will give up the property.

David Schwartz, co-founder of the New York-based Slate Property Group, said:

Patrick Carroll, CEO of developer Carroll, said he recently won two South Florida deals after his company dropped out of the contract with the original buyer.

“When this happens, lenders become super, super-selective,” Carroll said.

When the pandemic struck New York City in March 2020, opportunistic investors Ready to attack.. But thanks to record low interest rates, government stimulus, and abundant capital, distressed play was barely feasible. Now those dynamics are changing.

SL Green’s Matthias said that rising interest rates on LIBOR or SOFR to 3% would “pressure the capital structure.”

“You could see some interesting distressed opportunities,” he said.

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