Real Estate – The Hedge Against Inflation

Alex Draganiuk, Managing Director

What is inflation? As one of my old Economics professors said simply, “Inflation is too many dollars chasing too few goods.” Another way to say, an increase in purchase prices and a decrease in the value of money and purchasing power.

We can talk about the reasons for the current inflationary situation another time, but suffice it to say, there are plenty of reasons, and plenty of blame to go around. Regardless, we are where we are, so let’s talk about how real estate performs relative to inflation, and what property types perform better in a high inflation environment.

Rising inflation favors property types with a shorter than average lease terms, like multifamily, single-family rentals, self-storage, and hotels (which effectively lease up daily) because landlords can effectively recoup increased costs from increased rents in the short-term.

Alternatively, properties with longer lease terms, like office, retail, and some industrial deals will be subject to whatever terms are remaining on their leases of 5, 10, 15 or even 20 years.

Those leases could be flat or have annual rent bumps growing at 2-3%, which would have been plenty to offset any increases in operating costs until inflation began spiking since early 2021.

Those rent bumps were meant to offset potential losses from increases in operating expenses, but in a high inflationary environment, like what we are experiencing today, those base rent increases are insufficient to cover those much higher costs. So, those properties are seeing the erosion of their net operating income, and therefore their value.

Those properties with longer lease terms should also be able to command higher rents, once tenants renew or new tenants are installed at higher rates, but it will take longer for them to appreciate.

The exception to the rule of real estate being a hedge against inflation, occurs during periods of stagflation, which used to be a theoretical concept until it actually happened in the 1970s. That is where you have high inflation and very low or negative growth.

In those cases, landlords are unable to capitalize on rent growth, which is either muted or nonexistent, and they get hit with the double whammy of higher costs and greater vacancy.

We can discuss inflation and stagflation more next time.

Visit our website for more information about Loan Sales and Real Estate Sales.

Mission Capital is a subsidiary of Marcus & Millichap.

The Imbalance of the New York City Real Estate Market

Pierre Bonan, Director

Converting office buildings to residential use is not a new concept in New York city real estate. However, the idea is re-emerging as a way to counter pandemic-related market shifts. There is an imbalance in the New York City real estate market. We have an oversupply of arguably obsolete office space and a drastic undersupply of reasonably priced residential real estate.

This situation has existed for some time now and the trend towards remote work resulting from the pandemic has had a significant negative impact on office fundamentals, making the imbalance worse.

For example, Yelp recently announced that it was leaving offices in 3 major US cities including two locations totaling 270,000 SF in Manhattan. In announcing the decision, Yelp’s CEO cited an employee survey that found that 86% of their workers preferred to work remotely. And explained that when they reopened these offices, utilization was less than 2%.

Kastle Systems, which measures office occupancy based on key card swipes, pegs current office attendance in NYC at approximately 40% of pre-pandemic levels.

From 1995 to 2006, a tax incentive program known as 421g enacted for Lower Manhattan enabled more than 15 million square feet of conversions from office to residential use. Under this program, the owner received several substantial property tax benefits.

Residential conversions have also been completed successfully in other markets. In 2021 alone, 151 commercial properties across the country were converted to apartment buildings.

So what are the prospects for future conversions in New York City?

Manhattan currently has 37 office buildings exceeding 100,000 SF where at least half the building is listed for lease and this only accounts for the publicly listed available space. Many of these distressed office buildings are encumbered with large mortgages. On the surface, there is no shortage of conversion candidates.

A well-executed residential conversion generally costs far less than new ground-up multifamily construction. However, there are some significant challenges to executing this strategy.

Possibly the biggest physical obstacle is that many office buildings have large floor plates that lack accessible light and air in the interior. One possible solution is to use the interior of the building for storage, home offices or other amenities that do not require windows.

Zoning is another big obstacle. Many of the city’s office buildings are located in areas zoned only for commercial uses. Earlier this year, NY State Governor Hochul proposed zoning changes that would make office-to-residential conversions much easier. However, these proposed changes were rejected by the State Legislature.

It was recently announced that 55 Broad Street, a landmarked 425,000 sf, 30 story building in the Financial District was sold and will be converted to 571 apartments. The sale price was $180 million, which equates to $425 PSF. This price is substantially lower than most other Manhattan office buildings that are currently listed for sale.

This imbalance is a big problem with no easy solution. To the extent that mortgages on these buildings are underwater, these loans may need to be sold. It will be interesting to see how this situation evolves over time.

Visit our website for more information about Loan Sales and Real Estate Sales.

Mission Capital is a subsidiary of Marcus & Millichap.

Single Family Securitization Collapse Loan Sales

David Tobin, Senior Managing Director

Mission actively makes a market in whole loan single family pools arising from legacy securitization collapses (securitization collapse loan sales). At the same moment that interest rates have gapped out and new single family origination volumes have dried up, demand for these seasoned performing loans has never been stronger. Regional and community banks that hold single family loans on balance sheets have contributed to this inexhaustible appetite for a number of reasons:

Visit our website for more information about Loan Sales and Real Estate Sales now.

– Unprecedented liquidity resulting from slack commercial loan demand, unused PPP funds, elevated post-COVID payoffs and an overall flight to the safe haven of the United States.
– Low commercial loan margins due to spread compression and competition between lenders.
– Unexpectedly strong bank credit metrics, high GDP growth and economic activity.

Typically, these single family pools have similar characteristics:
– They consist of performing loans originated prior to the financial crisis.
– They exhibit slow prepayments for varying reasons, including HAMP balances, prior delinquency, property condition or unappealingly small unpaid principal balances
– They live in securitizations that have substantial realized losses.
– They have limited compliance risk.

Harvesting these pools is a complex process, involving the cooperation of call right holders, trustees, servicers, collateral custodians, bondholders and MSR owners. Completed transactions resemble landing multiple planes almost simultaneously during rush hour but occasionally the process resembles herding cats.

Mission’s securitization collapse loan sale process navigates these hurdles and produces maximum recoveries for all constituencies involved and eliminates the administrative, reporting and servicing burden of odd lot securitizations. With housing price appreciation still strong, it’s an opportune time to price and sell these portfolios.

Visit our website for more information about Loan Sales and Real Estate Sales.

Mission Capital is a subsidiary of Marcus & Millichap.

Mission Capital and Marcus & Millichap’s Q2 Joint Marketing Efforts

Austin Parisi, Associate

The joint marketing effort between Mission Capital and Marcus & Millichap contributed to the recent successful auction of a $26,000,000 Non-Performing Loan secured by a largely vacant mixed-use building in the Nomad neighborhood of Manhattan.

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Mission Capital, a subsidiary of Marcus and Millichap, now leverages a platform of nearly 2,000 investment sales and financing professionals in 80 offices.  These boots on the ground have made Marcus the top investment sales broker in the United States based on transaction count over the last 15 years.  The proprietary comparable sale data and market research provided by Marcus increases Mission Capital’s valuation accuracy and execution success.

The joint marketing effort contributed to the recent successful auction of a $26,000,000 Non-Performing Loan secured by a largely vacant mixed-use building in the Nomad neighborhood of Manhattan. Mission Capital collaborated with the Anton team at Marcus & Millichap, who helped to accurately value the troubled collateral by understanding COVID-19 impacted lease up timelines, rental assumptions and the lengthy judicial foreclosure process in New York.  Of course, the combination of Mission Capital’s comprehensive investor data base of institutional note buyers and the alternative capital sources that typically transact with the Anton group was powerful rocket fuel for the aggressively bid live auction conducted on Real Insight Marketplace.

The benefits of the Mission Capital Marcus & the Millichap team extends well beyond traditional core asset classes. Our team is in the process of selling a Single Room Occupancy, or Co-Living asset in the Mission District of San Francisco. The persistence of COVID-19 variants has led to prolonged elevated vacancies in the SRO rental market since March of 2020 as remote workers migrated to cities with a cheaper cost of living. As people begin to transition to a post-COVID-19 world, employees are returning to gateway cities, which is evident by the rebound in urban multi-family rental rates as well as increased demand for SRO assets. In developing our valuation thesis and marketing plan, Mission Capital drew on its own expertise in arranging financing for co-living assets in the San Francisco – San Jose market and Marcus & Millichap’s Taylor Flynn.  Taylor is the leading investment sales broker of Co-Living and SRO properties assets in San Francisco.

The culture of sharing market intelligence and sales expertise throughout Marcus & Millichap’s various lines of business continues to be imperative to effectively advising our clients and generating positive outcomes.

joint marketing effort Mission Capital Marcus & Millichap

Credit Facilities

Alex Draganiuk, Managing Director

Credit Facilities are a critical tool for all non-bank lenders in today’s fast paced credit market. These lending relationships come in all shapes and sizes, including warehouse lines, repo facilities, term loans, subscription lines, and facilities with hybrid characteristics.

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Credit Facilities are a critical tool for all non-bank lenders in today’s fast paced credit market. These lending relationships come in all shapes and sizes, including warehouse lines, repo facilities, term loans, subscription lines, and facilities with hybrid characteristics of any of the above, for both commercial and residential lenders.

A well-structured facility expands lending capacity, accesses a lower cost of funds and increases ROI through leverage.

Subscription lines and some warehouse and repo lines are designed for very short-term use, allowing aggregation of enough loans for securitization or the issuance of a CLO (with even lower costs of permanent capital). Typically, these gestation lines will be for 30 to 120 days at a time to facilitate someone’s lending business with recycling features.

Warehouse and term credit facilities also allow for purchases of pools of performing or non-performing whole loans from the secondary market, to extract loans from a lender’s own CLO or to leverage REO assets acquired via foreclosure or a deed-in-lieu.

These acquisition facilities are usually made for a 2 to 3-year term to allow a lender maximum flexibility to restructure a nonperforming loan, seasoning of the reperforming loan and subsequent redeposit into a CLO.  The added benefit is providing a borrower sufficient time to finish its business plan or conduct a sale or refinancing process to take out the existing lender.

It is critical to arrange these complex facilities when a lender CAN versus when a lender NEEDS TO.  The lender then has this tool in its quiver at when the world goes crazy due to COVID, war, political instability, or hyper-inflation.

The extra leverage of structured credit facilities provides lower cost of capital dry powder to play offense when others may be running for cover.

High Street Retail in SoHo: Up, Down or Sideways

David Tobin, Senior Managing Director

Up, down or sideways? What’s happening in Manhattan’s world famous SoHo neighborhood? Are rents going down? Watch to learn about the trends we see developing right now in the high-end boutique leasing market. Share this with anyone who follows Manhattan real estate.

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Real estate nerds like me love a great site tour. And there are no better sites to tour than High Street retail in markets like San Francisco, Santa Monica and New York City. While Manhattan sub-market rents in Meatpacking and Bleecker Street appear to be permanently lower, one market that is demonstrating resilience is the Soho District of Manhattan. The key high-end boutique corridor in SoHo is Mercer Street, home to the Mercer Hotel, the Fanelli Cafe, & many cutting edge boutiques.

Last dollar psf debt loads on certain retail condominiums in Soho have approached $4000 to $5000 per square foot.  Because of this, we have seen a number of sub and non-performing loans secured by retail condominiums trade in the secondary market, particularly cash out refinance loans predicated on rents between $500 psf and $750 psf.

We walked on Mercer Street corridor to figure out what is fantasy and what is reality in the post Covid leasing market.

In addition to following reported leases, one way to read the tea leaves is to read the construction permits posted on the front of buildings undergoing retail tenant improvements.

Recent leasing activity includes Softbank-backed Vuori, a take on LuluLemon, with 6,000 sf at 95 Mercer and a new build out of an existing boutique by Tory Burch. Additionally, we were able to identify at least four more spaces that have been leased and are under construction totaling nearly 22,000 sf.

49 Mercer- 7,750sf – signed July 2021 -no rent or tenant listed
53 Mercer- 6,100sf – signed sep 2021 – $225 PSF – F.P Journe – 10 years
77 Mercer- 5,100sf – signed December 2021 – no rent or tenant listed
149 Mercer- 3,600sf – Signed Feb 2022 – no rent or tenant listed

These include 49 Mercer, 53 Mercer, 77 Mercer, 149 Mercer.

The reported rents on these new leases range from around $250 per square foot to north of $500 per square foot.

At the same time however, we noted signs advertising active pop-up retail leasing opportunities.

Retail is very block-specific in Soho so it remains to be seen whether the consensus rent in the $250 per square foot range becomes the norm or if key spaces continue to touch $500 psf.  One factor is clear, basements don’t necessarily count anymore toward the headline rent per square foot figure.

Look for our compare and contrast analysis of occupancy on a block-by-block store-by-store basis from summer 2021 to summer 2022.  We will try to figure out the macro trends in this micromarket.

Gateway Cities

David Tobin, Senior Managing Director

In our latest video, David Tobin, Senior Managing Director, discusses expectations and trends he’s spotted in Gateway City loans (that’s New York, Los Angeles and San Francisco, in particular), and what this means for Loan Sales in 2022.

Visit our website for more information about Loan Sales and Real Estate Sales now.

Gateway city loans will continue to struggle in 2022 with low rates, extensions and restructures necessary to support portfolio performance. We see ongoing structural issues in the office, retail and hospitality sectors in New York, San Francisco and Los Angeles.

“According to Green Street, 70% of office workers will work remotely at least part-time within the next five to ten years…reducing demand for office space by about 15% and accelerating an ongoing deurbanization trend.”

Kastle Systems’ back-to-work barometer measures key card and fob system activity and shows a 40.6% physical occupancy of office across 10 top US cities with NYC and LA the bottom dwellers at between 36% and 37%.

Negative pre-COVID retail and banking trends were accelerated by the pandemic, particularly in urban locales.

CVS recently announced a 10% reduction in its 9900 store chain as grocery offerings and prescription sales continue to migrate on-line and over saturated infill locations right size.

Of 85,000 total bank branches today, nearly 3,400 closed in 2020. Urban located bank branch closures far outpace all other areas across all demographics because of competitive over-expansion pre-pandemic and continued digital disruption.

Manhattan sublease office space exploded during the pandemic peaking at 21.3mm sf in June 2021 compared to 8.2mm sf in 2016 and 11.6mm sf on the eve of the pandemic.

Finally, business travel continues to struggle with the biggest group oriented large format full service hotels, particularly in urban locations and less competitive select service hotels everywhere with PIP and cap ex issues.

What does this mean for loan portfolios? Persistently low interest rates have subsidized asset prices and gateway city loan portfolio collateral value for years. The specter of real inflation for the first time in a generation combined with real regulatory enforcement of asset quality and a real need for actual debt service payments will drive de-risking of bank balance sheets in 2022. We expect loan sale activity to continue to be muted but priced aggressively as liquidity rules. Hospitality loan sale offerings have been and will continue to be a robust bright spot in an otherwise anemic trading market. The wildcard? Inflated equity markets rapidly deflating and liquidity disappearing.

Accurate Loan Pricing

David Tobin, Senior Managing Director

In this new video, David Tobin, Senior Managing Director, describes accurate loan pricing and what to look ahead at in Loan Sales for 2022.

Visit our website for more information about Loan Sales and Real Estate Sales now.


Accurate loan valuation and pricing is critical for many reasons:

1. It sets expectations appropriately between buyers and sellers and allows for objective evaluation of whole loan bids
2. It properly sets PCI marks, reserves against impaired loans and allows for a release of reserves when the opportunity presents itself.
3. It is critical for mergers and acquisitions and loan portfolio investment decisions.
4. …and It ensures accurate movement of loans into a held for sale status

Model complexity, however, doesn’t enhance reliability. Pricing accuracy increases for three basic reasons:

1. The volume and frequency of loans and portfolios priced, including large data set evaluations for entities like the FDIC, FHLBs and HUD
2. Using Transaction Tracker intelligence to triangulate recent actual note sale results against financial reporting and publicly available data in an opaque marketplace
3. Marking to market collateral values in real time

Accurate qualitative data from comparable loan sale, investment sale, and financing transactions properly validates quantitative financial models. This guards against confirmation bias that occurs when flexing sensitive model assumptions that can exaggerate model outcomes.

What does this mean for loan portfolios? In 2022, regulators expect CARES Act 4013 designated loans to either return to the line or be properly risk rated as a TDR. Understanding true loan value for these assets in an opaque, fast paced and volatile marketplace can mean the difference between booking gains or incurring losses on difficult to price assets. PCI loans marked before or during COVID very often have embedded gains that should be monetized at high water mark pricing. As the Fed finally begins its tapering, selling risk into frothy markets at or above intrinsic value will be a winning strategy for 2022.

Thursday, October 28th, 2021

Pricing for Seasoned Performing Loans with David Tobin, Senior Managing Director

New Video

One of the most impressive characteristics of the recent surge in fixed income assets is how deep and strong the market is for seasoned performing loans collateralized by both commercial real estate and single family homes.

Why is this?

  • Persistently low rate environment
  • Unprecedented payoff velocity of existing loans
  • Unprecedented liquidity at banks generated by unspent COVID stimulus and a year of excess savings

How should financial institutions take advantage of this?

  • Examine loans at the lower end of the rate spectrum
  • Evaluate credits that were questionable pre-COVID
  • Consider exposure to businesses that peaked prior to COVID
  • Like with equity rallies, sell loans into this demand vortex

Even with the absence of call protection, premium transactions for seasoned higher rate loans are common place.

Pre-financial crisis era loans which may have been underwater (due to subordinate financing, collateral value issues or both) are now “in the money”.

In a market where asset prices are at historic levels, but where fundamental economic issues exists in certain hotspots, an equity market sell off will impair value across all asset classes and cause spreads to blow out. It is an opportune moment for portfolio balancing.

 

Who is Mission Capital?

Mission Capital Advisors, a subsidiary of Marcus & Millichap Capital Corporation, are experts in marketing loans secured by real estate. Learn more about who we are, what’s new, and why Mission Capital can help you with your loan sale needs.

The video features David Tobin – Senior Managing Director, Alex Draganiuk – Managing Director, and Spencer Kirsch – Vice President. Contact information can be reached at the following links below.

David Tobin can be contacted here.
Alex Draganiuk can be contacted here.
Spencer Kirsch can be contacted here.

 

Transcript:
Mission Capital is a full-service commercial, residential, and consumer loan sale, valuation, and advisory firm. We provide a wide array of services on behalf of our institutional and governmental clients through our tech-driven due diligence and trading platforms.

What’s new?
In November 2020, we were acquired by Marcus & Millichap, the #1 commercial real estate investment sales brokerage in the nation. The acquisition has significantly expanded our sales network and access to best-in-class research and local “boots on the ground” market knowledge.

Why Mission Capital?
We have been a top-tier loan sale advisory firm by volume every year since formation in 2002. Our extensive investor database consists of over 40,000 loan buyers for virtually all collateral types, and through our newly-formed partnership with Marcus & Millichap, we have added direct access to over 2,000 investment sales and financing executives in 82 offices across the US and Canada.

Secondary Market Liquidity for Hospitality Loans

Spencer Kirsch, Vice President, Loan Sales and Real Estate Sales

Spencer Kirsch, Vice President of Loan Sales & Trading, describes the state of the secondary market for hospitality loans, along with how buyers and sellers have altered their view of the sector over the last several months.

Visit our website for more information about Loan Sales and Real Estate Sales now.

Full Transcript

It’s no secret how material the effect of COVID has been on the Lodging sector in the U.S. With COVID-restrictions in place and a sharp decline in business and leisure travel, the occupancy, ADR, and RevPar figures across the industry plummeted by the end of 2020. Per TREPP, in Q4 2020, the overall delinquency percentage of lodging loans on bank balance sheets was 13.3%, significantly increased from the 1.1% delinquency rate in the first quarter. Additionally, by Q4 2020, lodging occupancy rates had dropped to 43%, well below the 72% rate present in Q4 2019.

Hospitality-focused debt firms and private equity firms alike have quickly identified an opportunity to raise capital to deploy in the sector. These firms banked on the opportunity to buy loans at discounts and restructure debt at higher interest rates or take title of the real estate. However, this capital was raised at a point when banks and other note holders were first starting to implement deferral or forbearance plans and were not ready to sell deferred loans at a discount and book losses. This led to a 6-month period of little-to-no hospitality loan transactions executing in the market from Q4 2020 through Q1 2021.

Fast-forward to present day, when the majority of deferral periods have ended or are close to ending, yet the sector is still a-ways away from stabilization and hotel bottom-lines are insufficient to cover debt service. Banks and other note holders who are unable or unwilling to implement further deferrals for impaired assets or don’t want to go through foreclosure processes are now more amenable to selling loans and realizing a controlled amount of loss. This has increased the opportunity for investors to acquire impaired hospitality loans at a discount to Par, with exit strategy optionality in-play.

At the same time, there remains a plentiful amount of hospitality-focused investment capital waiting to be deployed, along with a newly-formed, positive outlook on the industry. June in particular has brought upon a number of encouraging signs, as the country hit the 50% mark of vaccinated individuals, flight traveler count increased to more than 2 million for the first time since March 2020, and June hotel occupancy hit 61% across the US, which is the highest percentage in the pandemic era. The combination of excess dry powder and positive economic trends has resulted in an increased amount of investor interest, as well as tamed forward-looking default projections and tightened required yields. Ultimately, these factors have enabled sellers to trade deferred, scratch & dent or non-performing loans at a manageable discount, which has proved to be more economical than negotiating a new deferral or going through a foreclosure process .

We at Mission have been quite active in advising sellers of performing and non-performing hospitality loans over the last quarter and have a number of hospitality portfolios in the pipeline. We have represented clients in transactions executing anywhere from manageable discounts up to Par pricing, while garnering interest from a wide-variety of investors, including banks, pension funds, hedge funds, private equity firms, and others. We expect the hospitality market to remain liquid through the foreseeable future as forbearance periods continue to end and debt holders continue to offload distressed exposure while the sector gradually moves toward stabilization.