Some Wall Street banks, worried that owners of vacant or struggling office buildings will be unable to make mortgage payments, have begun selling portfolios of commercial real estate loans in hopes of cutting losses.
It's an early but clear sign of broader distress in the commercial real estate market, which is being hit by the double whammy of high interest rates that make it difficult to refinance loans and low occupancy rates in office buildings due to the pandemic.
Late last year, an affiliate of Deutsche Bank and another German financial institution sold the delinquent mortgages on the Argonaut, a 115-year-old office building in Midtown Manhattan, to the family office of billionaire investor George Soros, according to court documents.
Around the same time, Goldman Sachs sold loans on a portfolio of troubled office buildings in New York, San Francisco and Boston, and in May, Canadian lender CIBC completed the sale of $300 million in mortgages on office buildings across the United States.
“What we're seeing right now is temporary,” said Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence.
Stovall said sales are growing “as banks look to reduce their exposure.”
The non-performing commercial loans that banks are trying to liquidate represent just a fraction of the roughly $2.5 trillion in commercial real estate loans held by all U.S. banks, both in number and value, according to S&P Global Market Intelligence.
But these measures signal that the banking industry's “fake it and extend it” strategy is losing steam and that some lenders are reluctantly accepting that many property owners, especially those in office buildings, will default on their mortgage payments — meaning big losses for lenders and a drag on bank profits.
Banks regularly “extend” the time that struggling property owners have to find rent-paying tenants for their half-empty office buildings, “pretending” that the extension will allow the landlords to get back on track. And given that interest rates are much higher today, lenders have avoided forcing property owners to renegotiate expiring loans.
But banks are acting in their own interest, not out of sympathy for borrowers. When banks foreclose on defaulting borrowers, they face the possibility that theoretical losses will turn into real losses. The same thing happens when banks sell defaulted loans at a deep discount to the balance owed. But in the banks' calculations, suffering a loss now is better than risking an even bigger hit in the future if things go wrong.
While the problem with commercial real estate loans is serious, it has not yet reached crisis levels. The banking industry recently reported that just under $37 billion in commercial real estate loans, or 1.17% of all loans held by banks, are delinquent. Delinquent means that a loan payment is more than 30 days late. In the aftermath of the 2008 financial crisis, delinquency rates on banks' commercial real estate loans peaked at 10.5% in early 2010, according to S&P Global Market Intelligence.
“Banks are realizing they have too many loans on their books,” said Jay Neveloff, head of Kramer Levin's real estate law practice.
Banks are starting to explore how much of a discount they need to offer to entice investors to buy the worst loans, said Mr. Neveroff, who said he works for several family-office buyers that have been approached directly by several large banks for discounted loan-buying deals.
He said banks currently tend to pitch deals privately to avoid attracting too much attention and scaring off their own shareholders.
“Banks are reaching out to a select number of brokers saying, 'We don't want this to be public,'” Neveroff said.
Banks are also under pressure from regulators and their own investors to reduce their commercial real estate loan portfolios, especially after the collapse last year of First Republic Bank and Signature Bank, both large commercial real estate lenders.
Regional and community banks with less than $100 billion in assets account for nearly two-thirds of the commercial real estate loans on bank balance sheets, according to S&P Global Market Intelligence, and many of those loans are held by community banks with fewer than $10 billion in assets and lack the diverse revenue streams of much larger banks.
Hundreds of billions of dollars in office building loans are coming due over the next two years, said Jonathan Nachmani, managing director at commercial real estate investment and finance firm Madison Capital. Banks haven't sold off a lot of the loans because they don't want to take losses and there hasn't been enough interest from big investors, he said.
“Nobody wants to touch the office,” said Nachmani, who oversees acquisitions for the company.
One of the biggest institutional deals for commercial real estate loans came last summer when Fortress Investment Group, a large investment management firm with $46 billion in assets, paid $1 billion to Capital One for a loan portfolio centered on New York office loans.
Tim Sloan, Fortress' vice chairman and former Wells Fargo chief executive, said the investment firm aims to buy office space and debt from banks at discounts, but is primarily interested in buying higher-rated or lower-risk loans.
For investors, the appeal of buying discounted commercial real estate loans is that the loans could become even more valuable if the industry recovers in the coming years — and, in a worst-case scenario, the buyer could own the building at a discount after foreclosure.
That's the scenario unfolding at the Argonaut Building at 224 West 57th Street. In April, Mr. Soros' family office moved to foreclose on a delinquent loan it acquired last year from Deutsche Ariad Bank, a small German bank with a New York branch, according to court documents filed in Manhattan Supreme Court. One of the building's tenants is Mr. Soros's charity, the Open Society Foundations. A spokesman for Mr. Soros declined to comment.
Some commercial real estate loan transactions are structured in a way that minimizes any one buyer's loss.
In November, Rizmi Capital and a related company, Greenburn Investment Group, negotiated a deal with Goldman Sachs to acquire at a discount some of the most highly rated loans made to an office-building investment company called Columbia Property Trust, according to three people familiar with the matter.
Columbia Property Inc. last year defaulted on a $1.7 billion loan arranged by Goldman Sachs, Citigroup Inc. and Deutsche Bank AG, which secured seven office buildings in New York, San Francisco and Boston. All three banks had left parts of the loan on their books.
Greenburn partnered with two hedge funds in March to buy some of the similarly highly rated loans remaining on Citi's books, according to people familiar with the matter.
In doing so, Greenburn not only raised new capital for the transactions, but also spread the risk across multiple companies, reducing the total amount each company could lose if mortgage payments did not resume.
Both Goldman and Citi declined to comment.
Michael Hamilton, co-head of the real estate practice at law firm O'Melveny & Myers, said he has been involved in numerous transactions in which banks quietly gave borrowers a year to find a buyer for their property, even if the building was being sold at a steep discount. He said banks have an interest in avoiding foreclosure, and borrowers benefit by walking away from their mortgages with no debt.
“What I've seen is that cockroaches are starting to show up,” Hamilton said. “The public doesn't understand the seriousness of the problem.”
Julie Cresswell contributed reporting.