Investors Scoop Up Office CMBS Even With Some Towers Empty

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The success of remote working during the pandemic has prompted many to wonder if it could mean the death knell for office-tower demand in urban centers. But so far this month, the commercial mortgage-backed securities market is signaling it’s not worried.

Investors devoured a series of commercial mortgage bonds in recent days that were backed by so-called “Class A” office towers -- the highest quality structures in the best locations. The offerings featured or included new high-profile office properties or existing towers with strong tenants in place. Demand for some of the bonds was so strong that certain tranches were oversubscribed, and risk premiums tightened upon pricing.

“The last couple of office-centric CMBS deals were a vote of confidence from CMBS investors,” said Alan Todd, head of U.S. CMBS strategy at Bank of America Corp. “It shows that if there’s a good location, with good tenants and properties, office still makes sense.”

A nearly $1.5 billion CMBS for a new high-rise tower, One Manhattan West, part of the Hudson Yards development in New York, priced its AAA slice above par, and the entire capital structure was oversubscribed. Another small single-asset transaction securitized a brand new Silicon Valley office hub that’s leased 100% to Google -- a company that, ironically, recently announced its intention to allow employees to work remotely until July 2021. The bonds sold well despite the building standing empty.

And yet another so-called conduit, or multi-loan, deal that priced on Thursday was nearly 40% comprised of office properties, including 1633 Broadway, a 48-story building in midtown Manhattan that was the fourth largest loan in the transaction. That building remains mostly empty as employees continue to work from home, and at least two tenants have seen their rents either reduced or temporarily deferred, according to the latest servicer report.

Office Space Confidence

CMBS investors have faith that office demand will rebound even though the pandemic has accelerated the trend toward remote working and flexibility. Market observers say large corporations won’t give up their real estate, particularly in high quality buildings in central business districts.

“I do think that eventually people will return to the office, and over the long term a ‘Class A’ office property with strong leases and low leverage is a good investment option,” said Jen Ripper, CMBS investment specialist at Penn Mutual Asset Management LLC.

The One Manhattan West deal, for instance, boasted long leases and strong tenants including international law firm Skadden, Arps, Slate, Meagher & Flom LLP, accounting firm EY, and consulting firm Accenture Plc.

And although Google has extended its stay-at-home allowance for another year, it has yet to announce plans to let employees do so on a permanent basis, according to a presale report from rating firm DBRS Morningstar, which graded the Silicon Valley office CMBS.

“The uncertainty surrounding such changes poses a potential threat to office demand in the technology-dominated San Francisco and Silicon Valley area, which could otherwise be balanced by continued growth of the area’s technology sector and historically low vacancy rates,” DBRS Morningstar said in its presale report. Still, the ratings company “takes a favorable view on Google’s continued expansion and investment in its growing footprint at Moffett Place, which indicates its commitment to increase presence and staffing in the area.”

Vacancies to Rise

While securitized-credit investors have shown confidence in the return of office demand, others are not as sanguine.

In a report released this week, Moody’s Analytics said that vacancies for U.S. offices will rise past historic highs within the next few years. It projects the vacancy rate to rise to 19.3% in 2020 before surpassing the 1991 record of 19.7% to reach 19.9% in 2021 and 20% in 2022

“Many companies continue to push back returning to the office, with some already planning to telecommute until 2021. Whether the increased availability of remote working infrastructure will have long-term effects on office demand remains to be seen,” Victor Calanog, head of commercial real estate economics at Moody’s Analytics, said in a statement.

For instance, Morgan Stanley’s Chief Executive Officer James Gorman had previously indicated that the firm will have “much less real estate” as a result of the pandemic.

“However, the long-term nature of office leases means that it may take some time for vacancy rates to reflect the real trend,” Calanog said.

The office sector is also expected to incur “significant distress” in effective rents, which Moody’s Analytics sees falling by 10.4% nationally in 2020 -- including as much as 21% in New York and other markets.

Relative Value: Private-Label CMBS

  • The CMBS recovery has lagged other major sectors of the bond market, according to Joe Kalish, chief global macro strategist at Ned Davis Research Inc., and therefore the firm remains marketweight CMBS
  • Nevertheless, with the 10-year Treasury yield less than 70 basis points, CMBS valuations still look relatively attractive, Kalish said
  • CMBS 2.0 has underperformed its legacy counterpart for each part of the investment-grade credit spectrum. “In the search for yield, CMBS 2.0 may offer better relative opportunities”
  • A broader rent assistance program for households and businesses may be needed to avoid lasting damage to large swaths of commercial real estate. “Without fundamental improvement or better backstops, we prefer corporates to CMBS within investment grade,” Kalish wrote in a research note this week

Quotable

  • “The elevated number of marketplace-lending loans in forbearance has masked potentially negative performance for a significant portion of securitized pools,” Fitch analysts wrote in a note this week, in reference to MPL ABS deals. Most payment deferral programs offer hardship deferral programs of two to three months, and they may expire soon. “The total amount of borrowers, based on principal balance, that have elected to enter a deferral program has reached double digits for many issuers. In the absence of additional government assistance or extension of payment deferral plans, deterioration in trust performance is expected over the next several weeks and months.”

What’s Next

ABS deals in the queue for next week include Triton (container lease), JPMorgan Chase Bank (prime auto credit-linked ABS), and MidCap Financial Services (venture debt). Brigade Capital Management’s CLO, Battalion CLO 18, now led by Barclays, may price either today or next week.

©2020 Bloomberg L.P.

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