Some Wall Street banks, worried that landlords of vacant and struggling office buildings won’t be able to pay off their mortgages, have begun offloading their portfolios of commercial real estate loans hoping to cut their losses.
It’s an early but telling sign of the broader distress brewing in the commercial real estate market, which is hurting from the twin punches of high interest rates, which make it harder to refinance loans, and low occupancy rates for office buildings — an outcome of the pandemic.
Late last year, an affiliate of Deutsche Bank and another German lender sold the delinquent mortgage on the Argonaut, a 115-year-old office complex in midtown Manhattan, to the family office of the billionaire investor George Soros, according to court filings.
Around the same time, Goldman Sachs sold loans it held on a portfolio of troubled office buildings in New York, San Francisco and Boston. And in May, the Canadian lender CIBC completed a sale of $300 million of mortgages on a collection of office buildings around the country.
“What you are seeing right now are one-offs,” said Nathan Stovall, director of financial institutions research for S&P Global Market Intelligence.
Mr. Stovall said sales were picking up as “banks are looking to shrink exposures.”
In terms of both number and value, the troubled commercial loans that banks are trying to offload are a sliver of the roughly $2.5 trillion in commercial real estate loans held by all banks in the United States, according to S&P Global Market Intelligence.
But these steps indicate a grudging acceptance by some lenders that the banking industry’s strategy of “extend and pretend” is running out of steam, and that many property owners — especially owners of office buildings — are going to default on mortgages. That means big losses for lenders are inevitable and bank earnings will suffer.
Banks regularly “extend” the time that struggling property owners have to find rent-paying tenants for their half-empty office buildings, and “pretend” that the extensions will allow landlords to get their finances in order. Lenders also have avoided pushing property owners to renegotiate expiring loans, given today’s much higher interest rates.
But banks are acting in self-interest rather than out of pity for borrowers. Once a bank forecloses on a delinquent borrower, it faces the prospect of a theoretical loss turning into a real loss. A similar thing happens when a bank sells a delinquent loan at a substantial discount to the balance owed. In the bank’s calculus, though, taking a loss now is still better than risking a deeper hit should the situation deteriorate in the future.
The problems with commercial real estate loans, while bad, have not yet reached a crisis level. The banking industry most recently reported that just under $37 billion in commercial real estate loans, or 1.17 percent of all loans held by banks, were delinquent — meaning a loan payment was more than 30 days overdue. In the aftermath of the financial crisis of 2008, commercial real estate loan delinquencies at banks peaked at 10.5 percent in early 2010, according to S&P Global Market Intelligence.
“The banks know they have too many loans on their books,” said Jay Neveloff, who heads the real estate legal practice at Kramer Levin.
Mr. Neveloff said banks are beginning to put out feelers to see what kind of discount would be necessary to entice investors to buy the worst of the batch. Mr. Neveloff said he is working on behalf of several family office buyers who have been approached directly by a few big banks with deals to buy discounted loans.
Right now, he said, banks are inclined to market deals privately so as not to draw too much attention and potentially frighten their own shareholders.
“The banks are going to a select number of brokers, saying, ‘I don’t want this public,’” Mr. Neveloff said.
Banks are also feeling pressure from regulators and their own investors to reduce their commercial real estate loan portfolios — especially in the wake of last year’s collapse of First Republic and Signature Bank. Both had been major commercial real estate lenders.
Regional and community banks — those with $100 billion in assets or less — account for nearly two-thirds of the commercial real estate loans on bank balance sheets, according to S&P Global Market Intelligence. And many of those loans are held by community banks that have less than $10 billion in assets, and which lack the diversified revenue streams of far larger banks.
Jonathan Nachmani, a managing director with Madison Capital, a commercial real estate investment and finance firm, said hundreds of billions in office building loans are coming due in the next two years. He said banks haven’t been selling loans en masse because they don’t want to take losses and there isn’t enough interest from big investors.
“It’s because nobody wants to touch office,” said Mr. Nachmani, who oversees acquisitions for the firm.
One of the biggest institutional investor deals for commercial real estate loans occurred last summer when Fortress Investment Group, a large investment management company with $46 billion in assets, paid $1 billion to Capital One for a portfolio of loans, many of them office loans in New York.
Tim Sloan, a vice chairman of Fortress and former chief executive of Wells Fargo, said the investment firm was looking to buy office and debt from banks at discounted prices. But the firm is mainly interested in buying the high-rated or less risky portions of a loan.
For investors, the attraction of snapping up discounted commercial real estate loans is that the loans could be worth a lot more if the industry recovers in the next few years. And in the worst case scenario, the buyers get to take possession of a building at a discounted price following a foreclosure.
That’s the scenario playing out with the Argonaut building at 224 West 57th Street. In April, Mr. Soros’s family office moved to foreclose on the delinquent loan it acquired last year from Deutsche and Aareal Bank, a small German bank with an office in New York, according to court papers filed in Manhattan Supreme Court. One of the tenants of the building is Mr. Soros’s charitable group, Open Society Foundations. A spokesman for Mr. Soros declined to comment.
Some of the deals for commercial real estate loans are being structured in ways that would minimize losses for any one buyer.
In November, Rithm Capital and an affiliate, GreenBarn Investment Group, negotiated a deal with Goldman Sachs to acquire at a discount some of the highest-rated portions of a loan for an office building investment vehicle called Columbia Property Trust, said three people briefed on the matter.
Columbia Property, a real estate investment trust, defaulted last year on a $1.7 billion loan arranged by Goldman, Citigroup and Deutsche Bank. The loan was backed by seven office buildings in New York, San Francisco and Boston and all three banks had retained some portions of that loan on their books.
In March, GreenBarn then partnered with two hedge funds to buy similarly high-rated portions of the loan that sat on Citi’s books, the people said.
In doing so, GreenBarn not only brought in new money for the deal but also spread the risk between several firms — reducing the total amount any one firm could lose if the mortgage payments did not start up again.
Both Goldman and Citi declined to comment.
Michael Hamilton, one of the heads of the real estate practice at O’Melveny & Myers, said he has been involved with a number of deals in which banks are quietly giving borrowers a year to find a buyer for a property — even if it means a building is sold at a substantial discount. He said the banks are interested in avoiding a foreclosure and borrowers benefit by getting to walk away from a mortgage without owing anything.
“What I have been seeing is the cockroaches are starting to come out,” said Mr. Hamilton. “The general public does not have a sense of the severity of the problem.”
Julie Creswell contributed reporting.