Rating Agencies Criticized for High Scores to Failing Properties

Over $100bn in commercial real estate debt has been mis-rated, with some top-rated bonds linked to defaulted properties.

Jordan B.
June 24, 2024

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Good morning. Rating agencies have mis-rated over $100bn in commercial real estate debt, with at least a dozen deals maintaining top investment-grade ratings despite borrower defaults.

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TOP RATINGS

Rating Agencies Criticized for Giving High Scores to Bonds Backing Failing Properties

Source: Dave Simond / The Guardian

Despite facing foreclosure, bonds tied to single commercial buildings continue to receive top ratings from credit agencies, the Financial Times reports, raising concerns about the accuracy of these assessment reports.

A troubling trend: Credit agencies have been criticized for mis-rating over $100 billion in CRE debt. This issue is prevalent in single-loan mortgage bonds, which have become popular due to favorable terms for developers and floating interest rates that attract investors. Currently, single-loan deals make up about 40% of the nearly $700 billion in outstanding commercial mortgage bonds.

Case in point: 1407 Broadway, an office and retail building near Times Square, has dropped 73% in value since 2019, per CRED IQ. Now in foreclosure, the owner, Shorenstein Properties, has not made payments since July, and the $187mn in bonds tied to the building’s debt are still rated AA by Fitch.

Zoom in: Fitch recently downgraded the 1407 Broadway bond from AAA and put it on watch for further downgrades. AAA ratings suggest extremely low default risk; only Microsoft and Johnson & Johnson in the S&P 500 have such ratings. “You should never have a loss on a AAA-rated bond,” says Ethan Penner, who helped create the first commercial mortgage bond.

Gowing concerns: Scrutiny of these deals has intensified after investors recently lost 26% of their initial investment in a bond originally rated AAA and backed by 1740 Broadway, the former Manhattan headquarters of MONY. Blackstone bought the building for $605 million in 2014, but it was recently sold in foreclosure for $186 million.

➥ THE TAKEAWAY

Why it matters: Rod Dubitsky, a former Moody’s analyst, draws parallels to the pre-financial crisis period when agencies misrated subprime mortgage bonds. Experts argue that single-loan commercial mortgage bonds lack diversification and are less reliable. The Federal Reserve has also refused to accept these bonds as collateral for short-term loans. Critics urge rating agencies to improve their processes to prevent a repeat of past financial crises.

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✍️ Editor’s Picks

Real assets: More retirees prefer investing in real estate over traditional 401(k)s because real estate offers the security of tangible assets, steady rental income, and tax breaks.
State of the economy: Moody’s Economist Nick Villaunpacks the implications of two positive inflation reports and a stable Federal Reserve meeting for the broader economy.
Getting creative: As the era of cheap money fades, the world’s largest real estate investor must navigate uncharted waters in pursuit of stellar returns.
CRE investing: Jones Lang LaSalle CEO Christian Ulbrich reports an uptick in commercial real estate investments, identifying data centers as the hottest asset class.
Premium: Two major developers report that mass timber buildings are leasing faster and commanding higher rents than those built with standard materials.

🏘️ MULTIFAMILY

Unstabilized: BlackRock sold its 85 East End Avenue apartment building for $75 million to Farallon Capital, nearly two decades after tenants blocked a previous sale attempt.
Hot market: Silicon Valley has surged to become the sixth most competitive rental market in the U.S., driven by a resurgence in the tech sector and significant investments in AI.
Rent trends: While most U.S. metro areas have seen significant rent hikes, San Francisco is the only major city where one-bedroom apartment rents have dropped since 2019.
Affordable buy: SRM Development purchased the 358-unit Mill at First Hill in Seattle for $84 million, using an Amazon housing fund to make it permanently affordable at $234,637 per unit.
Motivation: Nearly half of younger renters plan to move by fall, and their most desired amenity is an in-unit washer and dryer.
Lower rates: Rent growth offers relief to landlords but may delay the Federal Reserve’s interest rate cuts amid Sun Belt supply gluts.
Moving ahead: Onni Group’s $1bn development near Bally’s planned casino in River West is advancing, with approval for nearly 2,500 apartments, retail, green space, and an amphitheater.

🏭 Industrial

IOS interest: Fortress Investment Group secured $708M in refinancing for industrial outdoor storage, led by Deutsche Bank, with a $493M CMBS loan and a $215M balance sheet loan.
TREX lease: Virginia-based TREX has leased a 324,000-square-foot warehouse at Mid-Atlantic 81 Logistics Park in Berkeley County, West Virginia, with Equus Capital Partners as the landlord.

🏬 RETAIL

Default: The $211.3M CMBS loan for Ovation Hollywood in LA has moved to special servicing due to imminent default after facing occupancy and cash flow issues ahead of its maturity date.
Brookfield exit: Six years after acquiring The Yards in D.C.’s Navy Yard, Brookfield Properties plans to sell three retail and mixed-use properties totaling nearly 92K SF.

🏢 OFFICE

Auction loss: A 145K SF office building in Rockville, Maryland, sold for $5.7M, ending a three-year decline after losing its sole tenant and resulting in $33.7M in losses for investors.
Shifting focus: JBG Smith is converting older National Landing buildings to apartments, hotels, and retail, while focusing on an office building with 43% vacancy to attract tenants.

PRODUCT REVIEWS & GUIDES

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📈 CHART OF THE DAY

The June release of the Green Street CPPI report showed the first positive pricing movement in commercial real estate since May ’22, roughly 24 months.