In early December, Andrew Chung’s Innovo Property Group wired a deposit and signed a contract to buy an HSBC-anchored 30-story office tower overlooking Bryant Park for $855 million.
As Chung scrambled to seal the deal at 452 Fifth Avenue, which would take him from scrappy industrial builder to Midtown office landlord, the Federal Reserve signaled it would raise interest rates to fight back. against inflation. In May, the SOFR rate – a broad estimate of how much it costs a bank to borrow – soared to 0.78% from near zero in mid-March.
Five months later, Chung missed his deadline to close the tower and lost his $35 million deposit.
While the deal came with various challenges — Chung struggled early on to raise equity and took a gamble by putting down the initial deposit, sources said — the rate hike certainly complicated things. Chung had to shell out more and more money to get financing. Innovo did not respond to a request for comment.
The public collapse of Chung’s deal for the HSBC tower has enthralled the city’s commercial real estate community, heightening concerns over rising rates.
“We really think it’s a good time to be the second-highest bidder on the deal.”
And while it’s the biggest deal to crash since rates began to inflate earlier this year, it’s far from the only one. Buyers, sellers and holders across the city are trying to adjust to an interest rate environment that many young professionals have never seen in their lives.
In June, the Fed raised interest rates by 75 basis points, the largest such increase since 1994. Economists expect similar hikes to follow in July and September.
Higher rates mean financing becomes more expensive, which means owners have to extract more money from their buildings to cover the costs. At least it makes sales more complicated, with all parties changing things on the fly.
“There are some trades I’m working on that haven’t had the retrades done yet, but we totally expect that,” said Andrew Sasson, broker at Ackman-Ziff. “Lenders are re-negotiating prices to borrowers amid transactions.”
The big thrill
As rates rise, transactions have slowed.
Nationwide, commercial property sales fell 16% a year to $39.4 billion in April, according to MSCI Real Assets, down for the first time in more than a year.
A flurry of maturing office debt will further test the market as landlords may find that they cannot borrow as much as they once did to repay their loans.
More than $7 billion in CMBS office loans in New York are due to mature this year, according to Trepp, more than in the previous three years combined.
Trepp’s Manus Clancy said in a recent podcast that higher borrowing costs would likely put pressure on homeowners who already had only a small buffer to cover their debt servicing costs. In these cases, it is likely that the owners will have to invest in the transaction when refinancing.
“At this point, it probably becomes a cash-in,” he said.
For homeowners whose debt is maturing, refinancing options have not only become more expensive, but also more limited. In addition to rising rates, the CMBS market has fallen in recent months amid inflation fears and instability in Ukraine.
“The CMBS market is not working very well,” SL Green Realty chairman Andrew Mathias told a Nareit conference in June. “There aren’t many cash buyers for Triple A bonds.”
With CMBS in decline, borrowers must instead turn to banks or debt funds for refinancing or new acquisitions. But even debt funds, which rely heavily on lines of credit known as warehouse financing, are closely tied to rate swings.
“If you buy a property stabilized at a tight ceiling [rate]it’s hard to fund,” said Ian Ross, founder of Manhattan-based development firm SomeraRoad.
Borrowers have protections against rising rates, but these too are becoming more expensive.
One of those protections – interest rate caps – has increased in price tenfold in recent months.
Lenders require most borrowers to protect against unexpected rate hikes by purchasing rate caps, in which a counterparty agrees to make payments to the borrower if interest rates rise above a certain point.
Six months ago, a two-year cap on a $50 million loan would cost a borrower $85,000, according to risk management consultancy Chatham Financial. That cap now costs $893,000.
“It went from a rounding error to a significant cost,” said Chris Moore, a member of Chatham’s property team.
Moore said volatility in commercial debt markets will continue to work its way to price caps. And as interest rates move, uncertainty about the cost of caps between when a buyer signs a contract and when they’re ready to make a deal is just another factor to consider. by borrowers.
“It adds an extra layer of uncertainty and potentially higher costs to underwriting,” he said.
Sellers may find that the interest rate environment warrants a more cautious approach.
David Ash, founder of Prince Realty Advisors, said landlords could seek to enter into more direct deals instead of a formal marketing process, which gives them and buyers more flexibility to consider changes in financing conditions.
“I see a lot more value in doing things directly and quietly with people they know they can work with and relate to,” he said.
In April, Vornado Realty Trust reached a straight deal to sell its Center Building office property in Long Island City at 60 guilders for $173 million. Vornado’s Jared Toothman and 60 Guilders’ Kevin Chisholm brokered the deal over dinner.
It’s clear that rising rates are making things difficult for buyers and sellers, but it’s not as if they can get around the problem by holding on.
After Chung’s deal to buy the HSBC tower fell through, its owner, Eli Elefant’s Property and Building Corp., had to refinance the property because its existing loan was coming due. PBC ended up paying a higher rate at 3.9% – effectively a penalty for not selling.
Ackman-Ziff’s Sasson said there was nowhere for salespeople to hide.
“The alternative is to borrow secure funding, and the funding market has also changed,” he said. “Either you get hit by the value when you sell or the interest rates when you go to finance it. »
Some believe that rising rates may present new opportunities as new deals fail.
In a few of these cases, the highest bidder in a transaction may not be able to complete the financing, leading bidders with lower bids to walk away with a property.
“We really believe the time has come to be the second-highest bidder on the deal,” said David Schwartz, co-founder of New York-based Slate Property Group.
Patrick Carroll, CEO of development company Carroll, said his company recently reached two deals with South Florida after breaking the contract with the original buyer.
“When times like this happen, lenders get ultra, ultra selective,” Carroll said.
When the pandemic hit New York in March 2020, opportunistic investors were ready to pounce. However, struggling games have barely materialized, thanks to historically low interest rates, government stimulus packages and abundant capital. Now those dynamics are changing.
SL Green’s Mathias said that if the LIBOR or SOFR rate increases to 3%, certain “capital structures will come under pressure”.
“You might see some interesting distressed opportunities,” he said.