During 2024, the office asset class — the property type facing the most widespread perception of being troubled — struggled. For a long time, lenders have been patient, largely because they didn’t want to be hit with big losses. However, some properties have faced such financial difficulties that waiting is no longer an option.
Gaps between initial appraisals and realistic valuations have spread in many, though not all, cases. This has shown up in multiple ways. Jim Costello, executive director of MSCI Research, found that private equity fund clients were regularly asking if the degree of asset value cuts they had made were similar in size to those of other companies. This shouldn’t have been the case if appraisal methods were objective, especially when the timing of changes could be selectively chosen.
Top-rated securities backed by solid real estate assets showed they could blow apart and leave investors whimpering. For example, investors in the AAA tranche of the $308 million debt backed by 1740 Broadway in midtown Manhattan only got 74% of their investment back after the loan sold at a steep discount. Creditors in the five lower groups were utterly wiped out.
Research by Bloomberg has shown that creditors in many single-asset, single-borrower (SASB) deals tied to an office building would likely only get a percentage of their original investment returned. "In multiple cases, the losses will likely reach all the way up to buyers of the AAA portions of the debt," Bloomberg wrote.
Some South Korean investment groups that made heavy bets on underwriting U.S. office tower debt have cut losses at heavy discounts. IGIS Asset Management had provided subordinated debt for 1551 Broadway in New York City, with its American Eagle store anchor, but sold its share at a reportedly heavy discount. Meritz Alternative Asset Management was a mezzanine lender on the 1.4 million square feet Gas Company Tower in Los Angeles. In 2023, the property was appraised at $270 million, down 56.7% from the $623 million valuation in 2021.
An obvious lesson is that owners and investors need to monitor valuations through multiple methods, including updated appraisals or datasets of current comp transactions — both coming from disinterested third parties so entities with direct financial interest can’t potentially manipulate the outcomes and give a false picture.
With advanced warning from property valuation and transparency to investors, another lesson is the need to anticipate the need for major capital injections and plan accordingly, which might include taking a loss and shifting to more valuable properties.
Bloomberg just looked at some major deals that showed the ups and downs, like SL Green Realty Corp. selling its 11% in the fairly new One Vanderbilt, near Grand Central Station, for a sum that valued the building at $4.7 billion. Trophy and Class-A offices have been better at maintaining value due to higher demand.
Then again, Beacon Capital Partners and 3Edgewood took a majority stake in the $485 million senior loan in Pacific Corporate Towers — a three-building complex in El Segundo, California. The price showed a more than 60% discount from Starwood Capital Group and Artisan Realty Advisors. The sellers had $605 million in debt and $120 million in mezzanine financing before giving up the deed instead of going through foreclosure.