TOP PROPERTY OWNERS ARE CREDITWORTHY -- THEY MIGHT DEFAULT ANYWAY / THE WALL STREET JOURNAL

Top Property Owners Are Creditworthy—They Might Default Anyway

Powerful investors such as Brookfield are starting to cut losing real estate bets to protect returns

By Carol Ryan

Brookfield has skipped payment on a $275 million loan on the EY Plaza building in Los Angeles. PHOTO: GOOGLE MAPS

Even if the property world gets a lot rockier, landlords with the deepest pockets should be able to service their debts. 

That doesn’t mean they will. 

Optimists point out that today’s real estate troubles aren’t as serious as the 2008 crash. 

For one, property investors are more creditworthy than the overly indebted and flighty homeowners who got banks into hot water during the global financial crisis. 

Of all the loans that Fannie Mae issued on single-family homes in 2007, around 16% wound up in default. 

Delinquency rates for commercial property are close to record lows today, although they are rising. 

And loan-to-value ratios are lower than they were 15 years ago, so owners with more equity in their properties will find it painful to walk away. 

But recent high-profile defaults show that creditors still face risks even from star borrowers.

Canadian money manager Brookfield Asset Management, with $825 billion in assets, has skipped payment on a property, and not the first one in this cycle: This time it was a $275 million loan on the EY Plaza office building in Los Angeles, according to Trepp. 

The delinquent loan is in the same portfolio as a pair of offices tied to more than $750 million of debt that Brookfield defaulted on earlier this year. 

It has also missed payments on a smaller loan on offices in Washington, DC. 

Brookfield isn’t alone. 

Pimco-owned Columbia Property Trust defaulted on a huge $1.7 billion office loan earlier this year. 

Blackstone has sent two separate loans on a Manhattan office block and residential building to special servicing, where a third party steps in to manage debts at risk of not being paid off. 

Among a Trepp list of office loans valued at $7.7 billion that have been sent to special servicing, more than a quarter is owed by big-name institutions. 

In some situations, powerful owners will be less willing to support a property through a rough patch than a small landlord. 

Family owners, in particular, may tolerate being out of pocket for a time if they plan to hang onto a building long term. 

The consequences of a foreclosure can be more severe for small borrowers. 

Heavyweights should be able to get another loan at a good price, even after a default. 

If a property is no longer hitting the return hurdle that the likes of Brookfield needs to satisfy its limited partners, they may decide to cut their losses.

“The thinking was that the institutions would be the last to give the keys back, but it may be the other way around in some cases,” says Rachel Vinson, chief operating officer for capital markets at CBRE. 

She adds that institutional investors that have a responsibility to act in the best interest of their investors will be laser-focused on the numbers.

An analysis of the delinquent EY Plaza loan by CRED iQ senior managing director Marc McDevitt shows that the Brookfield-owned building was 76% full at the end of last year. 

Net operating income increased a mere 2.4% in 2022, but mortgage payments jumped 47%. 

It looks like Brookfield hit the brakes quickly—perhaps as soon as the debt-service-coverage-ratio slipped below 1 and repayments on its mortgage would have to come from its own pocket.

The cost of interest-rate hedges is another major problem to watch. 

Around one-third of all commercial real estate lending in the U.S. is floating rate, according to CRED iQ. 

Most lenders of variable-rate debt require borrowers to buy an interest-rate cap that limits their exposure to rising rates. 

A borrower with a 2% cap will receive a payout when an interest-rate benchmark such as the Secured Overnight Financing Rate (SOFR) goes above this level to cover its higher debt costs. 

Replacing these hedges once they expire is now very expensive. 

A three-year cap at 3% for a $100 million loan cost $23,000 in 2020. 

A one-year extension now costs $2.3 million, according to data from risk adviser Derivative Logic. 

Property investors that can’t or won’t shell out these eye-watering amounts might opt to default. 

Landlords are being hit by higher costs from all sides. 

Big owners may wash their hands early to protect their bottom lines.