How a Recent Major CRE Bond Failure Happened

CRE investors have gotten a rude reminder of how badly investments can go. Those in the AAA tranche of $308 million debt backed by 1740 Broadway in midtown Manhattan received only 74% of their money, in May. The loan sold at a steep discount. Creditors in the five lower groups were totally wiped out.

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.

A terrible case, but what are the broader implications/? Did rating firms slip as they did in the time leading up to the Global Financial Crisis/? Reuters has an explanation of the events. They may not be a systemic problem as happened nearly two decades ago, but observing what can go wrong in current circumstances is important for any investor’s risk management.

One major issue in the case of 1740 Broadway was a delay in changes in ratings, ultimately blindsiding investors. Reuters reviewed agency reports and spoke with multiple experts in CRE mortgages. The group included one expert who was involved in the circumstances.

The story starts in 2014 when Vornado Realty Trust agreed to sell 1740 Broadway, a 601,000-square-foot office building between 55th and 56th streets in Manhattan, designed by the architects of the Empire State Building, to the Blackstone Group. The sale price was about $605 million, or $1,000 per square foot. The financial statement gain was approximately $443 million. The tax gain of about $483 million was deferred as part of a like-kind exchange for a previously reported acquisition of the St. Regis New York retail on 5th Avenue.

This was a time when CRE was still coming out of the GFC. Values were running up and there was money to be made. In 2019, things still seemed well. The New York Post reported on top-flight restaurateurs engaged to open restaurants on the ground floor and lobby mezzanine.

Something happened, though. In March 2022, Blackstone Group, the building’s owner at the time, turned the keys over to the CMBS trust that held a $308 million mortgage on the building, according to Trepp.

The agency reports and expert interviews, Reuters wrote, showed a failed attempt to sell the building in 2022, a growingly tough market which could explain Blackstone’s return of the property.

There were delayed property appraisals, leading to “the overly optimistic view for months of how much money the building could fetch to repay investors,” Reuters said. Two ratings agencies told the news outlet that they had published their ratings criteria and methodology as well as backing research into the problems the office sector was having, including price discovery.

The notification that the largest tenant, L Brands, would move out in March 2022 set off the default.

Blackstone told the news agency that it “worked with relevant parties to reach a resolution,” which would include turning the keys over.

The property went to a special servicer and there were efforts to find a buyer; one was reportedly willing to pay the full price, which would have made all the bondholders whole. However, this was when interest rates started kicking up as the Federal Reserve was battling inflation. By the end of 2022, the buyer pulled out.

Reuters said that the long sales process kept an independent appraisal from taking place, which would have shown the then-current market value and if it could have covered the bondholders. A switch in special servicers meant an appraisal wouldn’t occur until July 2023. After the appraisal was available, the building’s rating was cut to BB+ — below investment grade — and the bond values significantly declined.