Report suggests all loans originated over the last eight years are underwater now
Select asset classes in New York City’s commercial real estate market are experiencing a decline in prices – reaching levels last seen in 2009, according to a new report. And yet, the scenario offers a “once-in-a-generation opening” for investors to capitalize on normally unattainable properties, according to the findings.
Given the report’s vein, the title – “From Fear to Fortune” – is apt. The rest of the title is clunkier, but better explains its premise: “General Investment Opportunities in New York City Commercial Real Estate After the COVID-19 Pandemic.” The study’s author, Okada & Co. CEO Chris Okada (pictured), detailed his findings during a recent telephone interview. He began by providing an example of a building sale in New York City that illustrated the crux of his report.
“In a microenvironment, we’re seeing an incredible devaluation of New York City real estate,” he told Mortgage Professional America. “A building on Fifth Avenue owned by the Silverstein who built the World Trade Center sold the property they’ve owned for 20, 30 years for $400 per square foot.” All things being equal, he estimated what the normal cost would’ve been: “I’d like to think, at the top of the market, pre-pandemic, $900, $800 a foot. Land was trading at $600, $700 a foot at the peak now you get a whole building for $400 [per square foot].”
How is commercial real estate doing in NYC?
The upshot: “I think all the loans that were originated over the last eight years are today underwater,” Okada said.
While there are parallels to the GFC in 2008-09, today’s crises are not as cataclysmic, he suggested. What’s more, homeowners will be safe once the economic tide turns, unlike those during the Great Recession with subprime mortgages that soon went underwater. “I would like to say that the monetary tightening aspect and the interest rates aspect brought down valuations,” he said. “I believe in the next three years, rates will come down. The Fed funds rate – not to zero but certainly half of where we’re at. If we’re at 4.85% or 5% funds rate today, we’ll be 2%, and 2.5% in three years. It’s just not sustainable because of Treasuries and US debt. Comparing this to 2008 to 2010, we did $1 billion in distress and the difference before March 10, banks could just kick the can down the road because there was no major, headlining FDIC involvement compared to 2008. That’s gone! Now, the FDIC will come and seize on a Sunday night – they will now work weekends. And now the question is the value of all mortgages on balance sheets.”
The exception is home mortgages: “Not single-family,” Okada said. “If you locked in a 3%, 3.5% -- heck, even a 4%, 4.5% -- you’ve got 20, 30 years left; you’re fine. Homeowners are protected because no-one wants to sell. Why would you sell? You bought a house for $700,000 that by now is worth $650,000 but you have a 2.95%, 30-year fixed mortgage. What are you going to do?”
The office market has not been as insulated, Okada said, due to a “perfect storm” of factors, as outlined in the study.
Office use and hybrid work
According to a survey conducted by the Partnership for New York City published in February, 49% of Manhattan office workers were present at the workplace on an average weekday. The study also showed that, on average, employers project 56% daily occupancy will be the “new normal” in Manhattan offices. Additionally, 77% of employers plan to adopt a hybrid work model, largely based on employee preference, with 55% of employees in the office at least three days a week. Data from Kastle Systems, which tracks security card swipes in office buildings around the country, showed that workplace occupancy in the New York metropolitan area was 48.7% on Feb. 1, 2023, up from 47.5% on Jan. 25, 2023.
The data showed that in-office occupancy ranged from 26.4% to 60.5% over one week. “Despite being lower than average when compared to 10 major metropolitan areas tracked by Kastle, employers in New York City do not expect to reduce their real estate footprint and anticipate an increase in in-person work. In September 2022, 54% of employers said they expect headcount to increase or remain unchanged over the next five years.
Real estate, law, and financial services firms have the highest in-person workplace attendance, with real estate firms expecting an average daily attendance of 82% for January 2023, law firms 63%, and financial services firms 61%. Smaller firms with fewer than 500 employees are returning to the office faster, with 56% expected back by January. For firms with more than 5,000 employees, daily office attendance is expected to rise to 50% by the end of January, up from 44% in September.
“Although the report gives an upbeat forecast, the true vacancy rates still remain high, hovering around 20%,” Okada concluded. “This indicates that the demand for office space has not fully recovered from the impact of the pandemic. Furthermore, the decline in demand for office space has led to a significant drop in rental prices, with rents declining anywhere from 25% to 30% depending on the quality of the property. The decline in rental prices and high vacancy rates pose a challenge for landlords and property owners who are trying to attract tenants and maintain properties. With many companies opting for a hybrid work model amid the rise in remote work, the demand for traditional office space has been impacted, leading to the current state of the commercial real estate market in New York City. The situation is further exacerbated by the economic uncertainty caused by the pandemic and the potential for another recession in the near future. To remain competitive, landlords and property owners need to find innovative solutions to attract tenants and keep their properties occupied.”
The commercial real estate industry has faced a major challenge in the form of rising interest rates, Okada said. “Over the past year, interest rates have grown by 100%, impacting commercial real estate values in New York City and around the country. This increase in interest rates has made it more expensive for investors to borrow money and, as a result, commercial real estate values have declined.”
High interest rates hurt commercial real estate values in a variety of ways, he noted, chiefly in that it makes it more expensive for owners and developers to finance the purchase or development of commercial properties.
“This means that the cost of acquiring and developing real estate is higher, which reduces the number of investors who are able or willing to make these purchases,” he said.
In turn, this creates a decrease in demand for CRE, further leading to a decline in values. Additionally, debt service maintenance, as well as paying a monthly mortgage, has become more expensive as a result of rising rates, he noted. “The impact of high interest rates on commercial real estate values is being felt across New York City, with property owners of all sizes struggling to keep up with the increased costs,” he said. “This is particularly true for smaller landlords who may have limited access to capital and are more vulnerable to the impact of rising interest rates.”
Local government policy
“New York City is known for its high cost-of-living, but one of the main reasons it is so expensive is due to the city’s tight rent stabilization and rent control laws,” Okada concluded. “These laws have made it extremely difficult for landlords to rent out their vacant units, which in turn has made multifamily investment properties in the city undesirable for many investors. Rent stabilization and rent control laws in New York City are designed to protect tenants from unreasonable rent increases and evictions. However, the laws also impose strict restrictions on landlords, making it difficult for them to increase rents or evict tenants even in the case of non-payment. This has resulted in a situation where landlords are unable to turn a profit on their rental properties, which has a negative impact on the availability of affordable housing in the city.”
Hotel development restrictions
New York City is known for its vibrant tourism industry, but recent changes to the city’s commercial real estate landscape have made it difficult for developers to build hotels,” Okada noted. “Due to the lobbying efforts of The Hotel Employees and Restaurant Employees Union, developers can no longer build hotels without the review and approval of the union. This shift has taken away the option of land use for commercially zoned properties, lowering the value of dozens of neighborhoods across New York City.”
Historic rises in interest rates have put banks under tremendous pressure, Okada said, with hundreds of billions of dollars of unrealized losses. The collapse of Silicon Valley Bank, Signature Bank, and bank runs to First Republic Bank sent shockwaves through the global economy, and the dust has yet to settle on the exact amount of losses, he suggested. “The failure of banks has caused almost all financial institutions to pause their lending practices whether mortgages, business loans, letter of credits and other financial products to businesses, and in turn pulled all liquidity out of the economy,” Okada observed.
Okada has a unique perch from which to issue his findings. The Okada family has been involved in New York’s commercial real estate market since 1969, maintaining a dominant role to this day. Over the years, the Okada firm has brokered significant transactions, ranging from corporate office deals for Toyota Motor Co. to the expansion of retail giants like MUJI USA.
A “perfect storm” could nonetheless offer opportunities for savvy investors, Okada said. “Having operated in the New York City commercial real estate sector for 21 years, I am witnessing market conditions not seen since the 2008 financial crisis,” he concluded. “I believe the current state of the market provides ample investment opportunity in coveted and otherwise unobtainable New York City real estate. In 2008, when similar opportunities were available, those who invested capital into distressed assets achieved noteworthy financial returns.”