Unprotected Landlords Get Clapped by Rising Rates

Good morning. The cost of insuring commercial real estate loans has risen dramatically, with property owners now paying ten times more than they did a year ago to protect against rising interest rates. Struggling retailer Bed Bath & Beyond (BBBY) is reportedly talking with potential buyers about divesting some of its assets.

Meanwhile, a bill in the U.S. House would mandate federal agencies to go back to pre-COVID office operations, giving employees a 30-day notice to return.

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🎧 Podcast of the Day: Competition for New York City’s three casino licenses is heating up. Deconstruct sat down with SL Green (SLG) executive Brett Herschenfeld to discuss their partnership with Caesar’s (CZR) and why they’re pushing for a casino in Times Square.

Increasing Interest Rates Impact Landlords Unable to Bear Hedging Expenses

The expense of protecting commercial real-estate loans from an increase in interest rates has skyrocketed in recent months. Nearly 50% of CRE loans are floating-rate loans, and lenders typically require borrowers to purchase interest rate caps to hedge their exposure to rising rates, but the cost has drastically increased, which might cause a market downturn. 

Exponential growth: In 2020, Investors Management Group was able to purchase a 5% interest rate cap for one of its properties for $22,000. Today, a 2-year cap would cost them $1M—a whopping 45x increase! Obviously, IMG can’t purchase this cap, because it would dilute the deal’s returns. 

Any way you slice it: Landlords with expiring interest rate caps are finding themselves in quite a predicament and with no good options. They can pay for expensive caps now, refinance properties at higher fixed rates, or try to sell their properties in a challenging market. No matter how you look at it, it’s not a great situation to be in.

➥ THE TAKEAWAY 

The bottom line: Interest-rate caps are a useful tool for borrowers looking to limit the amount of interest they must pay on a loan. However, many investors didn’t buy interest rate protection prior to the run-up in rates, assuming rates would remain low.

The need to renew these caps is becoming an increasingly important issue in the commercial real estate industry, particularly in the speculative areas of the market where investors often borrow short-term, floating-rate loans to quickly renovate and raise rents on properties like apartments, offices, or retail spaces.

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FIRE SALE

Bed Bath & Broke: Near-Bankrupt Retailer is Selling Off Assets

Bed Bath & Beyond (BBBY) is looking to sell its assets, including its beloved Buy Buy Baby stores, to private equity firm Sycamore Partners to stave off bankruptcy. 

All or nothing: While Bed Bath & Beyond’s sales have taken a massive hit, Buy Buy Baby maintained a relatively stable position within its niche. Naturally, analysts believe Bed Bath & Beyond won’t sell anything unless it includes Buy Buy Baby, arguably the struggling brand’s most valuable asset. Aside from Sycamore, the retailer is also in talks with other suitors about possible M&A transactions.

Marching orders: As our favorite place to sniff soaps at the mall awaits its fate, management has continued with its “aggressive restructuring” plans, which include closing 150 stores and rebuilding inventory to include more household names. The company is also going through another round of layoffs, which should save another $80–$100M.

➥ THE TAKEAWAY 

Ain’t their first rodeo: Sycamore Partners has been around the block of distressed retail, having acquired big names like Staples, Belk, and Talbots. Sycamore’s interest in buying parts of Bed Bath & Beyond may be a sign of things to come in distressed retail, assuming the debt markets remain slow to recover.

SHOW UP TO WORK

House Bill to Require Federal Employees to Return to Offices

House Republicans introduced the SHOW UP (Stopping Home Office Work’s Unproductive Problems) Act of 2023 last week which would require all federal agencies to revert to pre-pandemic office arrangements and give employees 30 days to return to their offices.

Putting butts back in seats: The proposal letter cited the impacts of remote work on small businesses, public transportation systems, and taxing authorities. If passed, the bill would require the Biden administration to provide Congress with a plan to mitigate the negative impacts of remote work and report on agencies’ plans for federal property leases.

Get the popcorn ready: As of March 2022, the federal government and its agencies leased nearly 180 MSF in commercial space, which added up to $5.7B in annual rent. A survey of 24 federal agencies indicated that 19 planned to reduce their office footprint over the next three years. Clearly, if the proposed bill passes, it could have major implications for commercial landlords. 

➥ THE TAKEAWAY 

Call my bluff. Or don’t: The likelihood of the SHOW UP Act passing into law is vanishingly small, considering it would require support from a Democrat-controlled Senate and White House administration. But it’s also unclear if getting workers back into the office is a real priority for House Republicans, or if they’re just using the bill as a negotiation tool during congressional stalemates. However, if enacted, 

• Give me liberty: University of California workers unions are demanding that the system divest from Blackstone (BX), including its recent $4B investment in BREIT.

• Take a breather: Morgan Stanley (MS) CEO James Gorman is confident that deal flow will return as soon as the Fed stops hiking rates. Maybe he has a Palantir.

• The Great Migration: Over 1M people moved out of CA and NY during the pandemic. Meanwhile, states like MT, UT, and ID grew rapidly, creating new opportunities for property developers.

• A supply problem: MHN dives deep into the policies that will impact affordable housing in 2023, including the Affordable Housing Credit Improvement Act and the YIMBY Act.

• Office face-lift: With office vacancies climbing, more CRE players are pursuing creative conversion projects to capitalize on their unutilized workspaces.

• Who says nothing happens in Allentown? Philly, NJ, Worcester-Springfield, Allentown-Bethlehem, and Harrisburg, PA make up the top 5 Northeast markets for industrial construction.

• Dresses and dice: Hudson’s Bay Co., owner of Saks Fifth Ave, is the latest to join the race for one of New York City’s three casino licenses.

• Game of loans: The Chetrit Group is recovering from a near-default on a $481M loan by paying off $100M, selling 12 properties for $175M, and working on a forbearance agreement for the rest.

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• Tower transformation: Chiofaro Co. is planning a $100M transformation of International Place, a 1.8 MSF office complex in Boston. 

• South Street to South Korea: The Ghassemieh family has sold their boutique hotel in NY’s South Street Seaport to South Korean resort operator Sono Hospitality Group for $60M.

• If you plan it, we will build it: Homebuilding startup Welcome Homes raised $29M in Series A funding. The company lets customers buy land on which it builds a custom home within 6 months of permitting for a fixed price.

• The MOB: Big Sky Medical just purchased 10 medical facilities across TX, MD, CA, and LA spanning over 857,000 KSF, including the Greenpark MOB in Houston Medical Center.

• Shock the market: Honda Motor Co. (HMC) and LG Energy Solutions are partnering to build a 3 MSF battery plant in OH to meet the demand for EVs. It’s estimated to cost $3.5B.

• Package deal: Saint Gobain (CODYY) is building a 160 KSF manufacturing & distribution facility in Bryan, TX, estimated to cost $145M.

• Optimal living: Chicago-based Optima purchased a 22-acre site in Scottsdale to build Optima McDowell Mountain Village, a $1B residential project that was recently approved by the city.

📈 Chart of the Day

Nationally, only 16% of home builders have avoided price drops since the market peaked in March 2022, with most experiencing a decrease of -6% to -10%. Regional variations exist.

😎 Offering-MEME-Orandum

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DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.