BY DEES STRIBLING
By the middle of 2009, pundits, politicians, and prognosticators began calling commercial real estate a “ticking time bomb” set to blow up in the face of the financial industry. But by then the problem wasn’t anything new to the real estate industry, which has long been worried about CMBS-financed properties that aren’t refinancable—and the wave (or even tsunami) of commercial loans that are coming in the next few years.
In July, Rep. Carolyn B. Maloney (D.-NY) held a hearing to examine the problems of commercial real estate and the risks it poses to the broader economy. In her introductory remarks, the representative mentioned the “ticking time bomb” analogy, and then elaborated: “If mortgagers are unable to refinance or otherwise pay those large balloon payments, we could expect to see the default rate climb much higher,” she said. “That in turn translates into potentially crippling bank losses that our recovering financial system may yet be too fragile to withstand, even with recent indicators of some renewed confidence in banks’ financial positions.”
Calling “the market” a “time bomb” might be a catchy way to write headlines, but it obscures the reality that some markets are in more trouble than others, and that each property type is facing its own special brand of trouble. Even New York City, whose commercial real estate has arguably held its value better so far than a lot of other places—Las Vegas, Phoenix, Orlando—is suffering the slings and arrows of an outrageous economic slump, and that includes its large stock of multifamily rental properties.
In particular, New York has its share of apartment buildings that are currently skating on thin ice, financially speaking. “Until jobs return, there’s going to be a lot of pressure on a lot of apartment owners, especially on those who bought from 2005 to 2007,” says Tom Fink, senior vice president of New York-based Trepp LLC, which tracks commercial real estate lending and securitization. “Employment is the linchpin, affecting income levels and household formation, which in turn drives demand for multifamily housing.”
Thus far during 2009, the nation has watched the ranks of the unemployment swell, and no one is expecting the rest of the year to be much better, considering that employment is regarded as a lagging indicator. According to the New York State Department of Labor, as of June 2009, unemployment in New York State stood at 8.7 percent, the highest level since 1992, while unemployment in New York City is even higher, reaching 9.5 percent in June, a level not seen since 1997. In New York City for all of 2009, some 163,900 jobs are expected to be lost, with about 86,700 of those in Manhattan.
More than that, high-quality jobs have taken flight, and there’s no indication when they’ll come back. From March 2008 to March 2009, the financial sector in the city lost more than 30,000 positions, and the New York State Division of the Budget is predicting that another 30,000 financial-sector jobs will fly the coop by the end of 2012.
“You’d think that declining employment would impact for-sale residential housing more than rental housing, but that isn’t the case this time,” says Fink. “It’s counterintuitive, but household formation is down in a lot of places. People are rooming together in greater numbers and not moving into rental housing as much as before.”
Indeed, the U.S. Census Bureau says that household formation from March 2008 to March 2009 was 772,000, compared with some 1.63 million in the year before that. People are taking on roommates and boarders, adult children are returning to their parents’ homes, and immigration to the United States has declined significantly—and New York has always been a major entry point for immigrants.
According to Marcus & Millichap, the average vacancy rate in large, market-rate apartment buildings in Manhattan finished the first quarter of 2009 at 3.3 percent, still relatively healthy, though up 100 basis points from a year earlier. Yet due to employment losses and other recessionary pressures, “easing demand is forecast to increase the borough’s average vacancy rate 160 basis to 4.2 percent by year end,” the company’s most recent report on the multifamily market predicts.
Likewise, the report notes that the downward arc of occupancy among Manhattan multifamily housing is putting pressure on rents. “In an attempt to hold down vacancy, many owners are cutting rents,” the report notes. In the 12 months before the second quarter of 2009, asking rents declined 2.6 percent to $3,660 a month, while effective rents dropped 3.5 precent to $3,545 a month. And there’s more of that to come. During the last three quarters of 2009, Marcus & Millichap predicts asking and effective rents to decline 3.5 percent and 4.7 percent, respectively, to $3,595 a month and $3,449 a month.
“Rents have decreased in some markets more than others, and across the board,” agrees Richard Sussman, partner with real estate law firm Rosenberg & Estis, P.C. “The trend is going to affect most owners, but especially those who are stuck with overleveraged properties, born of the sort of financing that might have happened three or four years ago.”
“Overleveraged” might be a matter of interpretation, but for a property that borrowed from the CMBS market with a mezzanine loan on top of that, “it wouldn’t take much decrease in rent to impair your ability to keep current on your debt,” says Sussman. “The assumption underlying that kind of financing was that everything was going to go up.”
According to Real Capital Analytics, some 1,279 apartment properties nationwide were in distress in the first half of 2009, representing $18.8 billion in loans—an increase from the same period in 2008 of 97 percent.
Most properties in the New York multifamily market aren’t in such precarious straits, however. “Most borrowers aren’t facing default because their loans were more conservative,” explains Sussman. “At 50 percent to 60 percent of value, a 10 percent or 15 percent decrease in revenue probably won’t throw a property into default, though it will make the building a lot less profitable.”
Still, those properties that are yoked to higher leverage face not only declining rents, they also have to survive in a tight credit market that probably isn’t going to loosen up any time soon. Yet the demand for refinancing will certainly be there. According to Trepp, multifamily nationwide is going to need about $5 billion in refinancing through the end of 2009, about $9 billion next year, and $11 billion in 2011.
An upturn in the economy and the job market might help the prospect of refi for some properties, but many in the commercial real estate industry argue that waiting around for a recovery isn’t enough. “The current regulations could be made more flexible, to provide more certainty for a loan modification dialogue to begin,” says Jeffrey D. DeBoer, CEO of the Real Estate Roundtable. “Currently, these discussions can’t begin until a default is at the doorstep. Allowing a longer runway for that dialogue would be in the system’s best interest.”
Further, the Roundtable and other real estate interests have taken the position that a new credit facility should be created by the federal government to allow the refinancing of relatively healthy properties that nevertheless can’t refinance. “There simply aren’t enough new lenders out there right now,” DeBoer says. “That’s why we believe the federal government should explore creating a new lending facility.”
Back at the local level, some factors make the prospects of multifamily refinance more complicated in New York than other places. “In recent years in New York, some investors bought rent-controlled properties in anticipation of a smooth transition to market rate, and they’ve been hit twice,” notes Fink. “They’ve discovered that rent control isn’t so easy to get rid of, and on top of that, rents are coming down anyway.”
Perhaps nowhere illustrates that situation better than the massive Stuyvesant Town and Peter Cooper Village complexes, which Tishman Speyer Properties bought in 2006 for $5.4 billion, presumably a bubble price. “It isn’t likely that the debt on Stuyvesant Town and Peter Cooper Village is going to be refinanced,” says Fink.
Middle-class rents wouldn’t have been enough to service the debt associated with that kind of purchase price, so the new owner raised rents precipitously. The tenants fought back, and won a decision by the Appellate Division of the State Supreme Court in Manhattan earlier this year ruling that the landlord had wrongfully raised rents and deregulated many thousands of apartments at the complexes. The decision, if upheld, would also affect other New York landlords eager to be done with rent-control units. At press time, Tishman Speyer’s lawers were asking the New York State Court of Appeals to reverse the lower court’s decision, and the 84-acre Stuyvesant Town and Peter Cooper Village property was valued at about $2.13 billion by RealPoint.
Whatever the fate of rent control, the upshot of the credit crisis and the recession is that some multifamily owners will default. The real number is unlikely to be known for several years, however, until after borrowers have defaulted, properties have changed hands, and post mortems have been done.
“Banks are still reticent to call a default on a multifamily property,” says Sussman. “It’s pretty much the last thing a lender wants to do, and lenders will try to work with borrowers that they trust—by restructuring, deferring interest, abating interest for a short time, or some other strategy—to get through what everyone hopes will be temporary crisis.”
Kicking the can down the road, in other words. But there’s only so far that some cans can be kicked. “To some extent, the lenders’ hands are tied, since they’re responsible to bondholders to maximize value, which might mean they have to turn the properties over to new owners,” says Fink. “Each situation is going to be different, but there isn’t any doubt that we’ll see more foreclosures and more lawsuits going forward.”
