Let's say you are a typical corporate landlord who owns a sh-tload of apartment buildings. Odds are you put down 10-20% equity and borrowed the rest (paying and interest rate of about 2.5% interest). What happens if your loan matures? The deal doesn't work anymore? Not at interest rates over 7%. You can't get a new loan, can't raise additional equity and your lender forecloses. Eventually, they own the building, not you.
Is this going to happen frequently? Yup.
Is the same thing happen to office buildings? Yup.
Record High Manhattan Apartment Rents May Not Save Blackstone From Default
Cash flow from the properties isn’t enough to cover cost of all the debt, report says
By Will Parker, WSJ
April 25, 2023 8:00 am ET
Blackstone is in danger of defaulting on a $270 million loan backed by 11 apartment buildings in New York’s most expensive borough. PHOTO: MICHAEL NAGLE/BLOOMBERG NEWS
Apartment rents in Manhattan are soaring to new highs this year, even as rents plateau or fall in most of the rest of the country. Blackstone Inc. risks losing a portfolio of Manhattan apartments anyway.
The real-estate and private-equity firm is in danger of defaulting on a $270 million loan backed by 11 apartment buildings in New York’s most expensive borough. Cash flow from the properties isn’t enough to cover the cost of all the debt, according to a report from Moody’s Investors Service.
Apartments at the buildings were leased for an average of $3,700 a month in 2019. The median rent in Manhattan has increased another 20% to record highs. Since the Blackstone apartment buildings are mostly market-rate properties, the firm has been able to take advantage of the borough’s price increases.
But the rental boom hasn’t been enough to cover Blackstone’s growing maintenance costs on the 11 buildings, which were built between 1900 and 1987 and are mostly located in the Chelsea and Upper East Side neighborhoods.
These difficulties have landed Blackstone’s loan into what is known as special servicing, a process in which a third party steps in to manage securitized loans that are at risk of not being paid off.
After a surge in apartment rent prices in 2021 and the first half of 2022, rents across the U.S. have been falling in recent months, a sign that many tenants have maxed out on how much of their income they can devote to housing.
Manhattan rents have been a rare exception in continuing to push higher. Rents in the city went down earlier in the pandemic and didn’t recover until early 2022, a rebound real-estate brokers attributed to the return of office workers and students that have kept demand high.
But even New York apartment buildings can be difficult to make profitable if maintenance and improvement costs run too high. Many multifamily owners in New York and elsewhere have reported higher operating costs in recent years, including construction, labor and insurance costs.
Blackstone’s expenses related to managing the 11 properties, including making repairs and upgrades, have far exceeded its cost expectations when the firm took out the loan in 2019, according to loan documents and people familiar with the matter.
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Moreover, the properties were financed with floating-rate debt, which while typical for properties meant to be improved and then sold at a markup, involved interest-rate risk that made the cost of debt more expensive starting last year.
The buildings also suffered weaker rental income early on during the pandemic, when many New Yorkers left for the suburbs or moved to other parts of the U.S. That hasn’t been as much of an issue more recently. Average occupancy has since bounced back to 93%, according to figures cited by Moody’s.
At one of the properties, called The Grove, one-bedroom units lease for more than $5,000 a month and a three-bedroom penthouse there was listed for $16,000 a month earlier this year.
A Blackstone spokeswoman said the debt is nonrecourse, meaning the lender can only pursue the properties attached to that loan. The New York portfolio, she added, “isn’t representative of the strength we’re seeing in our broader multifamily portfolio. This portfolio faces specific challenges because significant capital was required to bring 60+ year-old product up to the standards we and our residents expect.”
Blackstone’s securitized loan comes due in August and it has the option to extend the loan term for one more year. Like other landlords, the firm purchased a type of hedge called an interest rate cap that partially limited its exposure to rising rates. But that cap expires in August, and the high cost of replacing it—likely millions of dollars—would further eat into the company’s income from these buildings, said Marc McDevitt, senior managing director at CRED-iQ, a property data and analytics firm.
Blackstone could soon choose to cut its losses and hand the properties over to the special servicer, which manages the loan on behalf of investors who hold bonds backed by the debt. The company could also try to renegotiate the terms of the loan to avoid losing the properties.
The 11 buildings represent a fraction of one Blackstone real-estate fund, which according to the company’s latest earnings statement is generating positive returns.
Prices of bonds backed by commercial real-estate mortgages have recently dropped to their lowest levels since the beginning of the pandemic, however, as investors grow increasingly wary of looming risks throughout property markets.
There is $37 billion worth of securitized multifamily loans set to expire in the next two years where rental income either isn’t enough to cover debt payments, or covers it with less cushion than is considered standard, according to real-estate data firm Trepp LLC. For comparison, that is more than twice the amount of at-risk loans in the office sector.
“I think there’s going to be a lot of buyer’s remorse,” said Manus Clancy, senior managing director at Trepp.
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