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Weekly Market Report - July 24, 2023

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The Real Estate Board of New York and Placer.ai have reported that same-day visits in Manhattan's office towers have increased to 73% of their 2019 levels during the first five months of this year. This is a positive sign of the slow but steady progress made by office buildings and employers. However, increased occupancy has not led to an office market recovery, as office availability has risen 79% since March 2020. Slow leasing has added challenges for office owners struggling with rising debt costs, with 15% of properties now worth less than they were recently sold for. The Manhattan Office Building Visitation Report found that workplace visits are heavily tracked on Tuesday through Thursday but not fully accurate appraisals of total activity in the building. The report also found that defining a full recovery of the office market as 100% occupancy is inaccurate. NYC's Department of City Planning is launching a two-year study into the impact of hybrid work patterns on the local economy, contracting with Placer Labs to develop methodology.



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Three downtown NY office buildings drove uptick in loans slotted as losses in Q2


M&T Bank reported a stabilized deposit base and earnings growth in the second quarter, but office distress rose as a pain point on the bank's balance sheet. Net-charge offs, a measure of debt unlikely to be paid off, spiked 156% year over year to hit $127 million in the second quarter. The bank's dollar volume of foreclosed assets rose nearly 50% to $43 million in the quarter, up from $29 million a year ago. Despite prominent office landlords grappling with loan defaults and in some cases opted to hand back keys on defunct properties, banks have yet to write down losses. M&T said clients were "really holding in there" and though owners might have one troubled asset, most were willing to work to throw in more capital to rightsize struggling properties. New York City office properties are projected to shed 44% of their pre-pandemic value by 2029, meaning loan losses will be greater the longer owners and lenders wait to workout distressed deals. M&T said office loans represent just 4% of its total loan book and New York City office loans comprise less than 1%. The majority of that debt matures in 2025 or later, a buffer for when the bank will need to write-down bad debts.



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Distressed investors are fighting over REITs trading at discount prices


Big fund managers in distressed investing are buying up shares in real-estate investment trusts (REITs), which were traditionally the domain of mom-and-pop investors. This has led to a rise in prices and benefits for individual investors who remained. However, the influx of distressed investors has also sparked conflict as hedge funds bid against each other for shares and clashed with management teams. D.E. Shaw, Flat Footed, H/2 Capital Partners, and Lonestar Capital purchased at least 20% of shares in a REIT called Diversified Healthcare Trust this year. The management company that runs Diversified Healthcare announced plans to merge it with an ailing office REIT it also controls, which the funds said would tank their investments. The two sides have since gone to the mattresses, fighting over the future of the REIT. The commercial real estate market is experiencing a downturn due to rising interest rates, office space demand, and the pandemic. Re distressed investors are flocking to REITs, especially those with low office exposure, as they are popular with individuals who lack the means to purchase and manage real estate themselves. The market capitalization of Nareit's index tracking all REITs has dropped by about $200 billion to $1.3 trillion over the past two years.



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New York City's largest office landlord, SL Green, experienced a dip in occupancy in the second quarter, but CEO Marc Holliday believes the issue is over due to a strong leasing pipeline. SL Green signed 43 office leases totaling 411K SF in Manhattan during the quarter, and the company reported a net loss of $360.2M or $5.63 per share. CEO Marc Holliday acknowledged a tough leasing environment in the first half of the year, but he highlighted the firm's "solid" performance: In the first six months of 2023, SL Green reported 915K SF of leases. Holliday said it has 1.1M of leases in the pipeline, and approximately two-thirds of those are new leases.


However, office occupancy dropped from 90.2% in Q1 to 89.8% at the end of the quarter, a "low point" for the firm. Holliday expects to gain occupancy from here and expects to reach an occupancy over 92.4% by the end of the year. Manhattan's availability reached a record high in the second quarter, reaching roughly 96.4M SF, a 78.9% increase since March 2020. Demand building is expected as businesses that hit the pause button during the prior three years are more frequently acting on plans for future growth, particularly in the finance sector, business services, healthcare, and education sectors. SL Green's same-store net operating income increased by 3.6%, and the same-store office occupancy at quarter's end was slightly ahead of December's projections. The company sold a 49.9% stake in 245 Park Ave. last month, valued at $2B, to Japanese real estate firm Mori Trust Co., which all proceeds went to debt repayment. SL Green plans to be more aggressive in share buybacks in later '23, particularly '24.



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Knotel bankruptcy decimated revenue at 22 West 38th Street


In June 2019, Mitchell Modell, then-CEO of Modell's Sporting Goods, acquired 22 West 38th Street for $61 million in a partnership with BEB Capital. The 12-story Midtown property was deemed stable by Modell, but its primary tenant, Knotel, was heading toward bankruptcy. Covid sparked a tenant exodus, putting the office building on even shakier ground. Now, Modell faces the loss of the property after defaulting on a $35 million CMBS loan. Special servicer Rialto Capital filed a foreclosure filing, citing the borrower's missed debt payment in February. Modell's problems at the building predate the pandemic, as the loan was first watchlisted in February 2020 after Modell diddled out numerous rent concessions, dragged down revenues and pressured the borrower's ability to cover debt service.


The loan was transferred to a special servicer in May 2020 for imminent default. Knotel's bankruptcy filing in February 2021 froze the case. By January 2022, net cash flow at 22 West 38th had plummeted to $160,000, and Modell's debt service coverage ratio hovered at a troubled 0.09. Now, Modell is on the hook for the loan's total unpaid principal of $35 million, plus default interest. The owner may also need to cough up cash to cover whatever an auction of the property does not. It's possible the building will sell for less than the loan balance.



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JPMorgan Chase is offering financing for a $350M loan backed by the HSBC Tower at 452 Fifth Avenue, which has struggled in the past year due to HSBC Bank's plans to downsize its office footprint and move its headquarters to a new location. The 30-story, 865K SF Midtown tower has been struggling, with attempts to sell it twice since 2021. Innovo Property Group failed to secure equity to close a deal, and the value of the tower dropped to $720M in September 2022 after refinancing from JPMorgan. US banking regulators have asked lenders to work with credit-worthy borrowers facing stress in the commercial real estate market.


The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corp, the National Credit Union Administration, and the Office of the Comptroller of the Currency issued an update of guidance on commercial real estate loan workouts in 2009, urging financial institutions to work "prudently and constructively" with good borrowers during times of financial stress. The new guidance includes short-term loan accommodations, such as deferring payments, partial payments, or providing assistance or relief to borrowers. Banks represent 54% of the $5.7T commercial real estate market, with small lenders holding 70% of CRE loans.

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