The Real Deal New York

CMBS turn toward trophy buildings

Commercial mortgage backed securities sees new level of momentum, as market turns toward well-known addresses

February 01, 2014
By C. J. Hughes

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At the height of the recession in 2009, the market for commercial mortgage-backed securities hit the very definition of bottom: Zero. No CMBS backed by New York City buildings were sold to investors that year.

The CMBS market — in which pools of real estate loans are bundled together and sold to investors — started a slow recovery after that. In 2013, it gained new momentum, this time with a twist. A significant number of these assets were backed by single buildings, and in many cases, they were trophy buildings with recognizable names and addresses, like 650 Madison Avenue, the Seagram Buildings and One Worldwide Plaza.

With interest rates still fairly low — about 4.5 percent for a long-term loan — and commercial property values on the rise in Manhattan, analysts say these vital bonds, which in a healthy economy typically finance about a quarter of all building acquisitions and refinancings in the city, are poised for more huge gains this year.

“People were declaring them dead a few years ago, and it was way too premature,” said Peter Mignone, an attorney in the real estate finance practice at the law firm Hunton and Williams.

Modest recovery

Lenders issued $12 billion in CMBS as part of 235 loans in New York City in 2013, according to the research firm Trepp. That was double the city’s 2012 CMBS tally of $6 billion and 119 loans.

While both were a significant jump over 2011, when $3 billion was bundled into 62 CMBS loans, the data show, the market is still a shade of its pre-downturn self. At the peak in 2007, the total for the city was $28 billion.

Nevertheless, the trend is clearly positive.

Another healthy sign, analysts say, is that building owners and developers are defaulting less, providing more confidence to the banks that securitize their loans and the investors who buy them.

In a troubling post-recession high-water mark, the delinquency rate in August 2012 stood at about 9.5 percent, according to Trepp, which considers a loan to be delinquent when a borrower misses at least one monthly payment. Contributing to the problem was that some of the loans that came due that year were issued during the 2007 boom, and carried unrealistic underlying valuations for the buildings that backed them, analysts said.

By December 2013, the delinquency rate dropped to 6.3 percent, a reflection of larger improvements in the office market.

This combination of factors means the landscape for CMBS loans is different these days. “The market’s exploding,” said Howard Michaels, chairman of the Carlton Group, a real estate finance firm that handles debt placement.

Single-asset anchors

Historically, CMBS loans contained batches of hundreds of sliced and diced mortgages from a wide range of office buildings from across the country, that not only varied dramatically in terms of size but also in the heftiness of rent rolls.

But sources said as property values increase and investors shy away from complicated bond offerings, CMBS loans are increasingly being anchored by a single asset. In fact, single-asset bonds made up an unusually large 29 percent of all CMBS loans in New York City last year, according to Trepp. In 2007, in contrast, single-asset bonds comprised just 6 percent of all deals.

Analysts said Manhattan buildings can be such strong assets, that a loan doesn’t need to have a diverse pool to attract investors.

“Their historic loss rates are very low, which has been another plus,” said Joe McBride, a Trepp research analyst. McBride said that in the pre-bust days, when multi-property CMBS loans covered so many buildings, they could be opaque and hard to gauge. A CMBS backed by one high-profile building can be more appealing to an investor, because it can be easier to assess the value of the bond as a function of the building.

The largest CMBS loan in the city last year was indeed backed by a single property — a $900 million offering for SL Green Realty’s 1515 Broadway, a 1970s office tower in Times Square that serves as media giant Viacom’s headquarters. Underwritten by Deutsche Bank, it was used to refinance a $775 million mortgage inked a year earlier, and allowed SL Green to pocket $116 million.

The fact that Viacom re-upped and expanded its lease in the 54-story, 1.6 million-square-foot building in 2012, setting itself up to become the sole office tenant by 2020 in the process, likely convinced Deutsche Bank that investors might be interested in buying the debt, analysts say.

“The long-term renewal of the Viacom lease, coupled with our redevelopment of the building’s lobby, common areas, retail space, and the introduction of LED signage, has created significant value,” said Andrew Mathias, SL Green’s president, in a statement.

CMBS deals like this one will stoke investor appetite “when no major event is set to occur, like a tenant leaving a building,” said Vincent Carrega, of Avison Young, a longtime commercial broker who wasn’t involved with the transaction. That’s because the appeal increases when investors know that the building will produce a steady stream of rent revenue.

The quick refinancing, just a year after SL Green got the mortgage from the Bank of China the CMBS replaced, also points to the rapid rise in Manhattan property values.

While it may also serve as a hint that froth is already returning to the market, some analysts instead say it’s more a result of the increased availability of debt.

“Credit availability is much higher now than it was a year or two ago,” McBride said. “It’s a virtuous circle: The more debt you can take out on a building, the more valuable it is.”

Other big-ticket CMBS deals in 2013, according to Trepp, included a $710 million loan last winter to refinance One Worldwide Plaza, a 59-story office tower in Midtown, on Eighth Avenue; the lenders on the deal were Deutsche Bank and Bank of America. Office tenants in the tower include Cravath, Swaine and Moore, the white-shoe law firm, which occupies about 600,000 square feet.

But the owners — George Comfort and Sons, RCG Longview and DRA Advisors — won’t be on the hook for all the debt payments. In October, they sold a 49 percent stake in the building to the real estate investment trust American Realty Capital.

Meanwhile, an investor group led by Vornado Realty Trust tapped a CMBS loan in the fall in its high-profile purchase of 650 Madison Avenue, a 27-story full-block office tower that’s home to fashion designer Ralph Lauren.

The buyers — Oxford Properties, Crown Acquisitions and Highgate Holdings joined Vornado — paid $1.3 billion, which included a $675 million mortgage that was packaged as a bond and then sold.

The deal, which was underwritten by Goldman Sachs and German American Capital Corp, was seen as evidence of the CMBS market’s health. That was because it closed in September, around the same time the market began focusing on the Federal Reserve’s plans to begin reducing stimulus efforts, which many feared would cause CMBS prices to drop.

It wasn’t only single-asset CMBS that picked up pace in 2013. The year also saw more traditional multi-asset deals like a $574 million refinancing of the Seagram Building at 375 Park Avenue. The debt on that building, which is owned by Aby Rosen’s RFR Holding, was folded into a $1.4 billion security along with 93 other properties nationally, according to news reports.

More trophy towers

In many ways, these high-profile building deals represent a new direction for CMBS. Traditionally, the beneficiaries of this type of funding were not stable trophy buildings in Midtown that portfolio lenders, who keep their loans on their own books, would gladly lend to; they were owners of riskier assets that many banks didn’t want to touch.

Then again, financial institutions tightened their purse strings in general since the recession.

And for all its strength, the CMBS market is still far below its 2007 peak.

“We are not there yet,” said Amit Doshi, a broker with Besen & Associates, a New York commercial brokerage.

But as credit spreads tighten, meaning that lenders can make more money on loans, more sources of funding are expected to emerge in the market, said Hunton and Williams’ Mignone, who said his clients include credit rating agencies that he could not name.

Other sources pointed to new players coming in to CMBS, like Ladder Capital and Rialto Capital Management, a division of the Miami-based Lennar Corporation, while institutions once active in CMBS lending are interested again, like Credit Suisse.

Yet for all the benefits to CMBS lending, there are still downsides for borrowers.

“Portfolio lenders are easier to talk to and negotiate with” than the servicers of securitized mortgage debt, Avison Young’s Carrega said. And if the deal is valued at less than $25 million, most CMBS lenders won’t even talk to a developer, said Aaron Jungreis, the president of commercial brokerage Rosewood Realty Group. Others noted that ground-up development deals also don’t pass muster.

Still, Jungreis said, “I encourage my clients to take all avenues in terms of financing. The CMBS market continues to be strong.”