Bondholders who bought the debt of US commercial real estate companies have suffered double-digit losses in the most prominent example of a reported “bubble” since the financial crisis.
What is striking is that quite a few of these bonds enjoyed an investment grade rating from the rating agencies, with some even being rated the highest AAA!
It is worth recalling that the three major American rating agencies (S&P, Fitch, Moody’s) bear enormous responsibility for the global crash of 2008, having prepared the ground with the irrational ratings on Mortgage-Backed Securities that were linked to “toxic” mortgages. Ratings that were purely based on interest rather than a detailed credit assessment.
Sixteen years on, AAA-rated bonds for commercial real estate companies, and especially towers, are under pressure in the US, hitting bondholders with double-digit losses not seen since 2008. Even more unlucky bondholders aren’t even getting paid the interest they’re owed , after the “cannons” of companies.
With 38% of US workers either working remotely or in hybrids, commercial real estate occupancy and rents are falling. This drove the value of the office buildings, in many cases, to a third of their value, causing some of the companies to default.
The result is that buyers of even the safest commercial real estate bonds are experiencing losses of 20%, 30% or higher — something that hasn’t happened since the 2008 financial crisis.
Example at 1407 Broadway in New York’s Garment District. Wall Street financiers considered the 43-story tower a robust profit machine. That prompted the owners to push a $350 million AAA-rated bond backed by the building’s rental income in 2019. Not even U.S. Treasuries are rated that high. But last June, investors in the AAA debt tranche were told they would not receive a $1 million monthly interest payment. Now investors are chasing the company to salvage what they can of their investment.
Another example is how a slice of a $115 million bond at the Peachtree Center in Atlanta is priced at 55 cents on the dollar. S&P Global Ratings originally rated AAA when the piece was issued in 2018. The rating has since been downgraded 17 notches to CCC.
The investment community believed that real estate values never went down. It was wrong after all.
Another stressor for commercial real estate debt is the issuance of a new class of bond that became popular after the 2008 crisis: a Single Asset, Single-Browder (SASB) bond tied to a single building. With commercial real estate prices at historic highs, SASBs looked like a safe investment. But the COVID-19 lockdowns worked disastrously.
