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New York office is the eye of the (office) storm. This is probably just the start of pain to come within Manhattan.
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RXR is one of the most respected office landlords in the game. The amount of maturity defaults in the next few years is going to be wild. Hundreds of office buildings in Manhattan are valued near their loan amount if not less.
I’ll just add to this a little more. If you assume NY cap rates pre pandemic for office were 5% exit caps. And if this exit caps expand to a 6% exit. The value just dropped about 17%. If exit caps are 6.5, values dropped ~25%. If you have 75% leverage for the latter example, your equity is pretty much zero’d out. In NYC office, it wouldn’t be crazy to think right now that anyone with 50% leverage, or more, has had half of all of their equity wiped out.
And that is assuming something close to full occupancy! Even at a 6 cap, you are banking on a return to office for most people - but almost certainly not pre-pandemic levels. You're seeing 25% of value wiped out on the basis of cap rate expansion alone, and you are probably also seeing a reduced rent roll even within the context of that higher cap rate!
What's the calculation for value dropping based on cap rate expansion? Thank you.
Net operating income divided by cap rate.
$5 NOI /5% cap rate = $100
$5 NOI / 6% cap rate = $83 value
I have exposure to roughly $8Bn (notional) loans in NYC office right now. I can tell you that the market is really bifurcated to Class A, and everything below. Most office values have fallen, but closer to 7-15%. Terminal Cap Rates in NYC were anywhere from 4.25%-5.25%, (Nationally top range is 8.50%), i have seen exit cap rates increase 0 bps to 25 bps on those numbers below. To be said, when reviewing appraisals, which is where banks derive their valuations for LTV, I have seen very few come in where the value is derived from sales cap rate comps. Essentially the DCF valuation is what primarily drives the valuation, and cap rate is a sound check. Obviously this is due to the huge variance per property in different TILC and CAPEX required. Discount rates have not really changed and are in the 6.0% to 6.5% range for NYC. Hold periods for some of these office buildings in the appraisals are anywhere from 11-20 year holds. I am worried that some of these appraisals are so tightly calibrated that moving the start date or end date out a month produces a wide variance in the valuation. What I can also say is that of my 20+ loans here some % leased of the total property has decreased slightly, and I have seen some office properties increase in lease up. The ones that have leased up are the better Class A. My class B's have slow lease-ups to no lease-ups in the past year, I have seen some non-investment grade tenants go dark.
To your point, most if not all of our loans are 65%-50% LTV. Only a few loans have had cash in refinances, but essentially these were heavy transitional properties with major leases expiring acquired before the pandemic. The real question is do the properties meet the extension criteria for their options? Even with rate hikes, most properties are above a 1.0x DSCR, but NOI has been roughly the same, sometimtes higher as rent steps help increase the revenue while taxes have decreased. Now for comparison these properties were operating from 2.0x-3.0x DSCR pre rate hikes. I think the long term leases really help out office here, and the 3/4 year initial term plus 2-3 year extension options enable the owners to hold their assets for 1-3 more years. What will really start to make me concerned is when and if a larger percentage of tenants go dark or get behind on their payments, and I haven't seen anything meaningful yet.
7-15% LOL
I’m sorry it is so funny. What is your experience with office and how major private equity institutions operate them? What are you seeing in your large structured office deals in Major Metropolitan markets? Specifically I’m the $200mm to $2Bn space?
I’m seeing foreclosures left and right, and loans underwater.
and you are in the Class A institutional office space? I've only been involved in 1 restructuring so far, but we saw it coming a year ago. What part of the capital stack are you seeing, lending on? Underwater from a senior loan perspective?
Yes - no one can underwrite an office building in Manhattan right now, spot values are unknown but almost every institution is out on office. With tenants downsizing and shorter lease terms cap rates are probably 6.0%+ for A, which would also be negative leverage if you can find a lender so probably higher. There are no data points though, it’s going to be a bloodbath. Seeing plenty of mortgages impaired.
I would say that most lenders, BB's anyway are and have been pencil's down. Asset class regardless.
"spot values are unknown" - then get an appraisal. This is in one respect a cheap shot, but a more nuanced point, would be that lenders downgrade on forecasts and upgrade on historicals. A spot value would mean that the property did and does not need to refinance, I am assuming it is a valuation in a point in time that does not have influence on refinance or extention.
I agree partly, with caveats of course, that leases signed have been shorter. I would disagree with the cap rate comments, at least how transaction are run. But i am less in the transacional space. A quick reference from you perspective would help remedy where you are seeing imputed and year 1 cap rates on transactions. From what I know there are few transactions happening, except for refinancing. And, even then the in place cap rate of 6%+ is not the rate that I see for refinances, at least in regards to how these properties are valued. As said above in-place cap rates are poor markers for office as the variance for capex and TILC vary from property to property.
Again, speaking to Class A.
Honestly, and not a negative. If I were to guess, you are a junior, an associate on a good to great firm. Likely brokerage, but maybe credit fund. This is on the basis of how you see valuation and the lack of depth of reply to my comments. Again, please don't take this as a negative.
the head of the magellan fund at fidelity used to say "if you can't summarize your argument on the back of a cocktail napkin, you don't know what you're talking about."
sounding smart and being smart are completely uncorrelated to your last point re: "lack of depth of reply." dumb comment tbh, as if comment length has any correlation to quality of thought
Oh did he really say that. Did you just read it once in a book, and that was all that you were able to glean, a snide commend about brevity.
No, you are incorrect, and to be pedantic, one can't literally "sound smart" in written word. I am relaying complex ideas on valuation, and some nuance to what position I come from. Without caveat, I have not literally seen values in office slashed by 50%, from my 20+ large office loan sample size, it has been +10% to -17%. I am not at a brokerage, I don't see all the deal that come through. As I have mentioned I am just relaying my experience.
The lack of depth comment meant that the points made were superficial, not pertaining to length. A kinder way to say this was someone who made the comment as armchair quarterbacking their comment. The points made clearly showed a lack of understanding of the nuances that of banking, valuation, and the future of the market. In vernacular, you read or heard some smart senior say something that makes sense, but you don't have the experience or knowledge to understand why those points were made.
Nobody cares where you went to school. Are you bragging you have friends who went to...good colleges? That is super, I know almost eveyone who teaches as Columbia, and NYU....not quite brag you think.
That last paragraph is a joke, you are a joke. I'm not replying back.
"real estate is fucked" is a perfectly valid statement. i don't need an A4 essay to make that point. it's a cyclical business and you're on a down cycle. get over it
A lot of people are completely missing the fact that C.R.E. Shervin is coming at this with his/her institutional lender hat. He/she is making an extremely cogent and coherent argument with very valid points. If you’ve operated in the institutional lender world whatsoever, you would understand completely what he/she is saying. And he/she is correct. From CRE’s POV, the deals he / she is working on haven’t been marked down. And from the lender world - that does make sense. We don’t have insight into the refi risk his/her portfolio has. But lenders aren’t worried about higher TI / LC / capex etc in the sense of if the deal has a guarantee and you have a fund on the other end - there’s enough equity to cover your loan position. Lenders work with appraisers to value buildings..period. To the good and the bad. And guess what, it works. Because appraisers are just as much deal flow as the brokers and have good information if you pick the right person. You just need to know. And CRE is pointing out the nuance saying - here is how the appraisers are changing their assumptions and why, and this is how we are dealing with the unknowns. That’s how these banks and debt funds all look at deals. And many of them are wicked smart. Debt has a slightly different view than equity. You don’t need to be 100% correct on the value of the equity. You just need to know your principal balance and interest payments are safe. And NYC class A office, while hard to finance and refi now, is doing really really well. There is a complete bifurcation of the market from a leasing perspective.
If your underwriting doesn't pencil on the back of a napkin, then it's a bad investment. The idea that if you can't summarize an argument in what amounts to a tweet means you don't know what you're talking about is absurd and stupid. The opposite is true. If you think you're making a coherent point in 100 words or less on any issue of any complexity, then you don't understand the argument. Nuance is everything.
Lenders holding CRE paper on their balance sheet have as much incentive as anyone to lie to themselves about the current property values. You can say values are down no more than 15% - but then we haven’t seen the forced selling yet have we?
Thanks for the thoughtful response. Interesting to hear you guys aren’t seeing discount rates increase. Curious as to why you think that is? I would have thought with the current uncertainty, discount rates would have definitely increased. I don’t know if it should be 50 bps or 200 bps, but would have thought they would expand.
cap rates are the least of the problem. no takers for 50% of office space in NYC
Cap rates will reflect that... do you not know what a cap rate is?
Just the tip of the iceberg, nationwide. It's going to be a bloodbath unless office usage patterns change dramatically.
There is zero refinance market for office. It’s going to be very bad.
Architects and developers should start thinking hard about creative ways to convert post-WWII office buildings to alternate uses. The big floor plates won't make it easy. Maybe there need to be some variances granted or building code changes implemented.
I just don't know what a lot of these end up being. The floorplates in so many of these buildings are just impossible to do anything with besides office.
We're several years into this already, people have been thinking about it. There just aren't many economically feasible paths.
Knock em down and start over.
Will be a huge write off. Frankly, maybe it's something that makes sense for companies with huge tax bills? Or developers that can afford to sell the losses? Buy a "fully leased" office building (by which I mean, leases in place, not actual occupancy) with rollovers coming soon, buy tenants out, get the building appraised at a more rational value, sell it into an LLC and take the loss and then have NewCo knock it down and build something more economically feasible? I'm sure there is a problem in there somewhere.
Office is just tricky right now and impossible to UW. Value declines depend entirely on lease rollover.
If you’re leased up then sure don’t expect much value drop. Have 50% of your Class A building vacant or rolling over? Then you are in for a long haul.
Does anyone know anything about RXR’s culture and compensation (salary, bonus structure, carried interest)
Location location location. I have to think that as time goes on people will continue to want to be around other people, as they always have, forever. This bodes well for office properties located near central hubs. The changing of where those hubs are is the root cause of the distress. As that shakes out and it becomes clear where people have decided to gather again I see a couple things:
Leases will be shorter
Office owners will be required (by the market) to update their building every 5-7yrs to continue to attract tenants at renewal. These props will be more amenity rich
Existing office props in bad areas are worth the price of the dirt. The floor plates for most of these properties are not conducive to any other use. This is the part of the market that may take another 5+yrs to sort out. Lenders who never planned on owning the assets will not act quickly and the props will sit useless until they all capitulate
Not really surprising. Everyone knew this. Just too many office owners wanted to blow smoke and act like everything was going to recover (talking about you Mr. Holliday and Mr. Ross for the ignorant/biased comments you two made back in 2020 about RTO). Rechler is the first reputable figure to speak out on this, that I know of. I get it that Class A stuff like SLG’s One Vandy, Brookfield’s Manhattan West, Tishman’s Spiral, or Related’s HY is performing really well. But also 99% of office is not Class A. It’s quite the opposite, most are outdated.
It’s extremely hard to do ground up Class A. I’ve seen some operators try to modernize older buildings but still that’s not Class A. Class is A is generally accepted as properties built within the past 5 years or so. I have even heard through the grapevine that L&L’s 425 Park ended up not being nearly as profitable as originally conceived because of how capital itensive Class A office is - it has to be well located and modern but then ALSO well amenitized like an apartment building.
Any “contrarian” investor who believes they’re different than all other operators and wants to bet big on office deserves to lose money because at this point, everyone knows office will not have the same value/functionality that the other asset classes will - multi, industrial, SFRs, etc.
There’s still some value in office, but trying to do business in an asset class that was significantly overbuilt and is now going through hell, does not sound smart.
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