Why conventional wisdom is wrong about Signature loan sale
Insiders doubt auction will reset commercial and rent-stabilized valuations
Since the Federal Deposit Insurance Corporation kicked off the sale of Signature Bank’s $33 billion in commercial real estate debt, the New York real estate industry has been watching, popcorn in hand, for the winning bids.
The expectation was that the prices paid would clarify valuations in what has become an opaque commercial property market. The industry has been short on data because rising rates and remote work have stunted office deals. The lack of comparable sales has further deepened the market’s paralysis.
“Signature’s loan sale will provide the ailing commercial real-estate market with one of the clearest benchmarks for how badly values have been eroded,” the Wall Street Journal wrote earlier this month.
But it’s not that simple, industry insiders say.
As rumors about bids roll in, a handful of factors — including the size and diversity of the loan pools, the structure of the sale and the likelihood that notes will trade again — may skew that benchmark.
Apples and oranges
The most glaring obstacle to discerning valuation is the grab-bag composition of the pools.
To attract bidders, the FDIC hacked Signature’s commercial debt into 14 slabs. Two are for bank bidders only. Nine hold $15 billion in rent-stabilized debt. And three pools valued at $17 billion contain loans backed by free market real estate.
Take the non-regulated debt, for which Blackstone is reportedly the leading bidder. It contains four different asset classes: office, hotel, retail and market-rate apartment buildings. Each has charted a different path through the pandemic and rate hikes.
Office buildings are gasping for air. Class B and C properties are selling for 35 percent below 2021 sale prices, according to an analysis by Maverick Real Estate Partners.
Market-rate rentals are in much better shape: Maverick found multifamily values slipped only 12 percent over two years. Rent growth helped blunt the impact of rising interest rates and Treasury note yields, which have caused rental building buyers to demand higher cap rates. Investors won’t accept 5 percent annual returns on risky real estate when they can safely make 4 percent on government notes.
It’s unclear what Blackstone bid on the loans, but in any case, the number will not reveal the differing valuations of commercial asset classes.
“You really can’t triangulate how much of the bid was allocated to office, how much to multifamily, to hotels, retail, right?” said Thomas Galli, a partner at Duane Morris representing some bidders. “It’s going to be very difficult to do that and come up with some conclusive evidence that reflects valuation, particularly when you’ve got performance varying all over the map.”
Degrees of decay
The nine rent-stabilized pools are split up by performance, according to a source familiar with them.
Since the 2019 rent law capped revenue in regulated buildings, their values have dropped. Maverick pegged the median decline at 38 percent.
Loans on buildings where most apartments are rent-regulated are likely in worse shape than those on largely free-market rental buildings. Similarly, mortgages made before the legislative change weren’t underwritten for stagnant rent growth and are more likely to be underwater.
But it’s unclear which loans are in what pools.
So, when Related reportedly bid 69 cents on the dollar for a 5 percent stake in $6 billion of rent-stabilized loans (about one-third of the pie), it’s anyone’s guess if it was valuing distressed debt, performing loans or something in between.
Amid that ambiguity, sources said the FDIC’s structuring of the sale invites overbidding.
In marketing the debt, the agency retained 95 percent ownership and offered the remaining 5 percent to private parties through joint ventures.
Owners of the loans make money in two ways: the payments by borrowers and the fees the FDIC pays to service the debt.
Income from the former is less predictable, particularly because the rent-stabilized loans figure to be in such bad shape.
But because the stake being sold is so small, the fees will provide a bigger chunk of the income, said Ben Carlos Thypin, CEO of real estate investment platform Quantierra.
“For the rent-controlled portfolio, everyone is making their money on the fees,” Galli noted.
Knowing this, bidders will “pay a higher valuation,” Thypin said, than if the investment opportunity had offered a larger stake in the less-reliable loan payments.
Second sales matter more
Sources expect the industry will get a better idea of pricing when the loans sell again.
Operating agreements will likely restrict when and how the winning bidder can remarket the debt. But an FDIC spokesperson did say joint venture partners could tap “any disposition strategy appropriate for the asset,” meaning a second trade is not off the table.
To turn a profit, winners will need to sell the loans for more than they paid, which will ultimately value the debt at a higher price. And winners will likely sell the debt in chunks, which will offer a more granular look at values than the initial sale.
“That pricing is going to be a lot more meaningful for price discovery than what the FDIC is selling it at,” a source working with one of the rent-stabilized bidders said.
With distressed loans, for example, marketing materials will give a sense of what the seller believes values to be.
The best gauge for valuations, though, will come when buildings sell at foreclosure, as some almost certainly will. Until then, any offers on a distressed note will factor in the time it takes to foreclose, legal fees, any capital expenditures needed in the interim and profit — all unknown variables to observers right now.
“A property sale is worth more as a data point than a loan sale,” Thypin said.
Mark to market?
Some have predicted that a discounted sale of Signature’s rent-stabilized loan book would set off a chain reaction of banks marking down their rent-stabilized debt.
Many in the industry call that unlikely, though. Banks typically don’t write down values until a delinquency or default forces them to.
Signature’s rent-stabilized loans are an example. Despite industry claims that the loans were “toxic,” only 4 percent were marked distressed when the FDIC seized the bank, according to an analysis by the University Neighborhood Housing Program, a nonprofit that has long monitored the portfolio. The bank’s own financial statements asserted near-zero delinquency.
It’s likely that other lenders in the rent-stabilized arena — New York Community Bank is the largest — will only record distress when owners fall behind or fail to pay off loans at maturity.
“[The sale] doesn’t necessarily mean the banks are going to start marking their loans that are impaired down to 70 cents on the dollar because this portfolio traded,” said Dan MacNamara, founder of CMBS-investor Polpo Capital.