Uh Oh. Investors in a Top-Rated CRE Bond Hit With Losses

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 wiped out.

It is “a really bad sign as to how deep the hole goes,” Bloomberg wrote. When everyone gets wiped out, including those holding the most highly-rated slice of debt, it’s like a wall full of red flags, languidly stirred by an economic sirocco. Reportedly this was the first such event in the post-pandemic era, according to Barclays Plc.

Bonds backed by single mortgages and tied to older office buildings dominated by one anchor tenant — like 1740 Broadway — are especially vulnerable, they say, adding that some analysts are already predicting further losses as more loans get sold for a fraction of their former value.

But according to other data, this isn’t a simple systemic response to a strong ebb tide, leaving everyone beached. Instead, in a saying associated with Warren Buffett, the retreating water showed who had been swimming naked. That would be people and institutions who were overly excited by cheap money and made terrible purchases they never should have contemplated.

The 1740 Building was formerly called the Mutual of New York, or MONY, building. It was bought for $605 million by Blackstone in 2014. To help finance the deal the firm took out a $308 million mortgage, which was packaged into a CMBS and scooped up by the likes of Travelers Cos., Endurance American Insurance Co. and others, Bloomberg  said. Reportedly Blackstone and the special servicer sold the building for $186 million a few weeks ago. The former told Bloomberg that it had written off the property nearly three years ago

The deal resulted in the repayment of the CMBS. But with additional losses from fees and advances, only $117 million was left for bondholders. Investors in $151 million of lower-rated debt were wiped out, while those holding $158 million of debt originally rated AAA suffered a 26% loss, according to Bloomberg.

“But while some analysts feared that Blackstone’s possible exit from 1740 Broadway augured future retreats by other landlords from the pandemic-battered office market, insiders insisted it was a one-off case due to a rare blunder by Blackstone’s EQ office division,” according to the New York Post. An inside source told the paper, “They overpaid for the building by at least $100 million and the loan terms left them no wiggle room to ask for lower rents. End of story.”

Whether the case in this instance or not, chances are that the low-interest, high-leverage atmosphere of the time between the post-Global-Financial-Crisis to partway through the pandemic convinced some portion of deal participants to push their luck. Higher prices? Not a problem because property values would always go up, interest rates would always be low, and rents could always be escalated to make a deal work. Until things changed. And there were probably more than one.