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Weekly Market Report - June 11, 2024

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As hopes of interest-rate cuts fade, some commercial real-estate borrowers want to cut loose


Higher-for-longer interest rates are forcing commercial property owners to reconsider their options, as inflation remains above 3% for three consecutive months and U.S. economic data remains robust. The secured overnight financing rate (SOFR) is expected to be 4.825% at the start of 2025, implying up to two small cuts this year. This has led to an increase in the cost of hedging, which lenders require borrowers of floating-rate debt to hedge their interest-rate exposure through interest-rate caps. The longer rates stay high, the greater the weight of unresolved property loans on lenders' books, and the deep freeze on property deals. Less deep-pocketed owners may decide to spend their cash elsewhere and hand the keys to lenders, making it harder to persuade landlords to invest in troubled properties.

 

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Manhattan's leasing market experienced a 70% increase in May, with 3 million square feet of office leases signed, compared to April's total of 2.3 million square feet. This is above the five-year rolling average of 2.3 million square feet but still below the 3.6 million square feet monthly average in 2019. However, landlords are optimistic as the city's availability rate dropped from 18% to 17.9% in May. The largest deal of the month was Bloomberg's renewal of nearly 1 million square feet at Alexander's Inc.'s 731 Lexington Ave., which demonstrates the impact of one or two mega deals on leasing volume. Lower Manhattan saw a 1.1% drop in availability, while Midtown and Midtown South saw increases in availability. Sublease availability in Manhattan also decreased by 4.2% compared to a year ago. Asking rents increased by 0.6% from April to an average of $74.59 per square foot, but are down from last year.

 

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After a double downgrade, Arkansas bank finds itself in the spotlight 


Bank OZK, the 55th largest bank in the U.S., has been downgraded from a buy to a sell by Citi analyst, sending its stock price tumbling 17 percent. The bank is arguably the most important in commercial real estate, writing checks for billions of dollars to the largest developers in Miami, New York, Chicago, and Los Angeles. In the first quarter of this year alone, it provided $688 million in construction financing. Critics have claimed this model is risky, with some pointing to Chicago-based Corus Bank, which was seized by regulators during the Great Financial Crisis after lending to condos. Bank OZK is the sole senior lender and has had minimal write-downs of its commercial real estate loans, with net income attributable to shareholders reaching $674.4 million, more than doubling since 2016. However, Citi's downgrade signals growing concern that the troubles impacting commercial real estate are rolling over to Bank OZK. The bank's construction lending totaled just $336 million in 2005 and reached $12.3 billion in the first quarter of this year. The bank's loan portfolio is not facing wide-spread distress, as the loans questioned by the Citi analyst still appear to be current on payments and there is substantial equity in those projects. However, the possibility of one of OZK's loans ending up in the non-performing category raises concerns.

 

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Media conglomerate’s downsizing hands Susquehanna full floor in Related property


Warner Bros. Discovery is reducing its Manhattan office space by subleasing 74,000 square feet from the media conglomerate at 30 Hudson Yards. Susquehanna International Group will occupy a full floor for the next decade until WBD's lease expires, then switch to a six-year direct lease with landlords Related Companies and Allianz. The asking rent for both deals is unclear, but typically in the $110s and $120s per square foot. Susquehanna is upsizing from 140 Broadway, where it took 54,000 square feet in 2020. WBD occupies 1.5 million square feet at 30 Hudson Yards, which was purchased from Related in 2014 and sold back to Related for $2.2 billion in a sale-leaseback. Construction on a 13-story, 375,000-square-foot space at 230 Park Avenue South began in 2019 and is fully dedicated to WBD today.

 

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Tough decision was to benefit “the 80% who’ve never redeemed,” CEO says


Barry Sternlicht has reduced Starwood Real Estate Income Trust's withdrawal limits, potentially impacting the fund for at least six months. Sternlicht hoped the increased cap on redemptions would be a six-month process, focusing on the benefit of the 80% of people who have never redeemed. He also criticized the Federal Reserve's "unbelievably ineffective" monetary policy, which he has previously criticized as the Fed raises interest rates to combat inflation. Sternlicht's comments came after SREIT tightened its limits on shareholder withdrawals from the $10 billion fund, moving the goalposts to 0.33 percent of net asset value each month. As of April, SREIT had $752 million in liquidity available, divided between cash, credit line, and debt securities. The liquidity issues began in October 2022 when redemption requests exceeded the 2% threshold. SREIT invests in industrial real estate, self-storage, and multifamily, which is under pressure due to slowing apartment rent growth.

 

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Square footage of renewals, extensions down sharply


Manhattan's office market is experiencing a decline in finance, insurance, and real estate tenants, particularly those in the finance industry. Square footage of renewals and extensions among FIRE tenants has declined by 27% from the three years prior to the pandemic to the four years most immediately impacted (2020-2023). Additionally, expansions, pre-leases of spaces under construction, and new deals have declined by almost 20%. The finance industry contributes the most to the FIRE equation, accounting for 67.4% of the sector in the last decade. However, emerging subsets of the sector, such as private equity, help the FIRE sector retain a vital role in the office landscape. Citigroup, Barclays, and HSBC are pushing for workers to return to the office five days a week, and the Financial Industry Regulatory Authority is expected to reimpose pre-pandemic work monitoring rules, potentially forcing more finance institutions back to the office full-time.

 

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Brokerage spends on talent, hoping for payoff when business comes back 1.83B in Debt


Newmark Group hired Doug Harmon and Adam Spies from rival Cushman & Wakefield as co-heads of its capital markets team to help prevent a national banking crisis. The assignment was a rush for brokers, but Newmark executives saw it as vindication and a way to overtake industry leaders. The Signature deal suggests the payoff for 12 years of building. Newmark, a leading CRE brokerage, has been spending heavily to opportunistically buy brokers or capital markets teams, hoping the investment will pay off when business returns. The company's growth plan is supported by its founders, Gosin and Lutnick, who have an iron grip on the company through a dual-class share system and a board of loyal directors. This has led to a struggled stock price and a lower multiple than other big CRE firms. The dual-class setup takes away institutional oversight, and problems can fester without checks and balances. In December 2021, Newmark paid Lutnick a controversial $50 million bonus, which investors want to claw back. The company dismisses the lawsuit's merit and maintains that the bonus award was properly approved by the compensation committee.


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Tax subsidies spur new housing;


New tax subsidies for affordable housing construction in New York have led to lenders reshaping new developments in Halletts Point, Mott Haven, and Flatbush. Refinancings were issued for L&L's office building, the Brodsky Organization's 18 Sixth Avenue, and the Monogram condo project in Midtown Manhattan. Wells Fargo extended construction loans at 20 and 30 Halletts Point, Wells Fargo extended a construction loan at 20 and 30 Halletts Point, Slate Lending provided $150 million to build a 450-unit multifamily project in Mott Haven, and the Chetrit family and the Jay Group received a $117 million refi of their mortgage at Sunrose Tower. New York's Webster Bank loaned $104 million to Hudson Companies for a residential building in Hamilton Heights.

 

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Hadi Hajjar, president of Mirtex Trading Corp. and Mihata Corp., is proposing to demolish over half a dozen 1-story buildings near Berry Street in Williamsburg, Brooklyn, to create a massive, L-shaped commercial and industrial complex. The proposed building would rise across eight lots owned by Hajjar's corporations, including on Berry Street and North 12th and North 13th streets. The first floor would contain retail with 4,800 square feet of open space, while the second and third floors would be slated for retail and light manufacturing. The fourth through ninth floors would be occupied by commercial offices, and the 10th floor would contain an 11,632-square-foot restaurant with outdoor dining on the roof level. The project is part of several changes planned for the north Brooklyn neighborhood, including the William Vale Hotel and the Bathhouse.

 

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Chinatown-based developer Thomas Sung has filed plans for an 8-story office building at 217 Canal St., which will span about 30,000 square feet. The site is currently home to a 1-story commercial building, built in 1910, and is home to a gift shop. Demolition permits have not been filed yet. Sung, who owns the building since 1973, filed plans for a similar-sized 8-story office building nearly a decade ago. He is also the founder and chairman of Abacus Federal Savings Bank, which serves the region's Chinese immigrant population. Plans for new office buildings have been rare since the pandemic, but leasing activity was strong in April and May. The availability rate remains around 18%, and total available space has grown by almost 80% since March 2020 to reach about 96.5 million square feet.

 

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Fitch Ratings has downgraded 90 Fifth Ave., an office building near Union Square, after it missed a tax payment. The building, built in 1903, faces rising vacancy rates and declining cash flow. Its anchor tenant, Compass, is subleasing space, and another tenant, Republic First Bancorp, was seized by the federal government and sold to Fulton Financial Corp. The building's $1.6 million property tax bill was paid in full last summer, and the mortgage is sent to special servicing. RFR acquired 90 Fifth in 2001 for $28 million, and the property's estimated value is $73 million. The building's mortgage is set to mature in 2027. Additional downgrades may occur unless the building's performance stabilizes.

 

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SL Green, New York's largest commercial landlord, has been re-elected and its CEO pay approved at the annual shareholders meeting. All seven SL Green directors were re-elected, despite opposition from Institutional Shareholder Services. The boardroom-election adviser recommended investors vote against two members for their role in awarding $18 million in pay to CEO Marc Holliday, a sum deemed excessive due to SL Green shares losing nearly half their value since early 2020. The directors opposed by ISS, University of Richmond law professor Carol Brown and private-equity executive Lauren Dillard, each received more than 75% of shareholder votes. The vote was not as decisive for Holliday's pay package, but it was approved by 66% of shareholders. SL Green's stock price has performed better than peers over the last six months, and the firm acquired two Manhattan office buildings this year from partners at ultra-low prices. Typically, investors approve CEO pay with more than 90% of the vote and directors receive similar support.

 

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New York is experiencing a boom in film studio space, with over 50 state-qualified facilities in place. Developers have built or renovated at least six major studio projects in the past five years, making the city competitive with Los Angeles and Atlanta. The wealth of studio space, along with the city's iconic skyline and generous film tax credit, is turning the Big Apple into Hollywood East. The newer studio wave has few geographic boundaries, with projects such as Sunset Pier 94 Studios and CIM Group turning office space into movie production locations. New York's tax credit system, including faster reimbursements, is driving the recent boom. The city's infrastructure, including public transportation and infrastructure, is well-positioned to build on its studio infrastructure improvements going forward. However, the industry may face headwinds from recent writers and actors strikes and a potential decline in content demand from major streaming platforms.

 

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Government retirement funds are selling property at a loss as the slump spreads

 

Government pension plans are facing a slow-moving commercial real-estate slump, with many fearing the damage is far from over. Canada's national pension plan is selling stakes in Manhattan and San Francisco office towers for $225 million less than it paid for them, while California's government worker pension fund unloaded a Sacramento property it had been trying to develop for almost two decades. Office holdings will continue to drag down returns in the $333 billion California State Teachers' Retirement System's real-estate portfolio, with traditional office space making up about 18% of the property holdings. Pension funds have reported less strain than private managers, with privately managed funds reporting a negative 12% return in 2023. The board overseeing Canada's $461 billion national pension plan is shifting the focus of new real-estate investment away from bricks-and-mortar buildings and toward infrastructure such as highways and energy.

 

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Higher Interests Rates and flattening rents scuttle projects

 

During the biggest apartment construction boom in decades, many developers are struggling to complete projects due to higher interest rates, tighter lending conditions, and flattening rents. The average construction time between construction authorization and construction begins has risen to nearly 500 days, a 45% increase from 2019. Developers are also launching fewer projects amid the financing crunch. The surge in building has led to more apartments than can be quickly leased without cutting rents, making some investors skittish about adding more units. Banks are souring on commercial real-estate loans, making developers need to raise more cash from investors to build. Cities like Boise and Worcester have been overdue for a spate of new housing construction.

 

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