Strategic Default: Comparing New York To Los Angeles
MyEListings' markets and economics editor and creates content about global macro events and their impact on US commercial real estate.
Many people, especially those working in the commercial real estate sector, have experienced economic instability and financial hardship as a result of the COVID-19 outbreak. This has resulted in a rise in strategic defaults, a pattern that is especially evident in urban centers like Los Angeles and New York, where the dichotomy between short and long. Here, we examine the recent surge in strategic defaults and contrast the two cities` susceptibility to this danger.
What Does Strategic Default Mean?
The practice of deliberately failing on mortgage loans by borrowers is known as strategic default. This is done to prevent further financial hardship. This may be the result of a number of factors, such as an inability to pay back a loan or a desire to keep possession of the property in the near future.
An Increase In Defaults In Both cities
In the commercial real estate sector, loan defaults increased from 2.4% to 4.4% between February and June 2020, according to Federal Reserve research, and it was predicted that the figure would continue to rise. In Los Angeles and New York, where a disproportionate share of office property owners have fallen behind on their loan payments, this pattern is particularly obvious. As an illustration, Brookfield Property Partners defaulted on two office towers in Downwotn Los Angeles, while Chetrit Group missed payments on a $85 million loan for a Hudson Yards project in New York.
However, over the past two years, conditions did not deteriorate as anticipated. Instead, they appeared to improve; but this could be an illusion. Short-term rates, as dictated by the Federal Reserve, have risen considerably, whereas longer-term rates have been relatively subdued, and real interest rates, which subtract inflation (because when inflation is present it benefits borrowers because they pay back their loans with cheaper and cheaper dollars) are just marginally positive.
Lenders Prepare For More Defaults
Because of the possibility of recession, as well as borrowers` strategic concerns, lenders currently anticipate seeing more office property defaults. As a result, they are approaching the market cautiously and are gradually requesting more room for loan renegotiations and giving borrowers more leeway. This helps lenders maintain their capital over the long run while also enabling landlords to maintain ownership of their buildings in the near term, thus pushing out any perceived need to default for strategic reasons.
Tougher Loan Conditions
Lenders are currently producing new loan agreements with harsher requirements in order to safeguard their assets. Increased capital needs, higher interest rates, and stricter debt servicing arrangements are some of these conditions. In other words, it is becoming quite costly (often prohibitively so) to refinance on market terms, and it is also quite expensive, though less so, to extend on current terms if the lender will allow it. There is simply too great a gap between where business was priced just last year, and where it is priced currently. Borrowers that extend loans are gambling that rates will decline by enough to make extending worthwhile so they can then refinance on better or equal terms. Those that elect to default are betting that offloading those obligations onto their lenders will leave them better off in the long-run despite the reputational and other penalties for default.
New York and Los Angeles Compared
There are also significant distinctions in the susceptibilities of the two cities, despite the fact that both are susceptible to subsequent defaults. For instance, the Federal Reserve study showed that between February and June 2020, loan defaults in the commercial real estate markets of New York and Los Angeles increased by 1.5% and 6.4%, respectively. However, this was only the first response of a very large, very deep market to a very large magnitude event. Next moves by the Federal Reserve, Congress, and state and local governments would take longer to take effect.
Once rate hikes began in earnest in March of 2022, they outpaced the ability of slower-moving real estate to keep up; in fact, because so many workers were shifted to work from home, and productivity actually improved as a result, requiring these workers to return to the office full time in an environment where a competitor could simply snap them up and allow them to continue as is could be self-defeating. Commercial office properties thus experienced vacancies that would not return by the current time, and might not do so at all. New York City currently has 18.6% of its office space available where Downtown LA has a massive 28.6% unoccupied.
In both cities, there have been several attempts by large corporate interests to re-energize the return to regular office work, but these have been lackluster in their reception. With interest rates having increased over 4 percentage points at the shortest end of the yield curve, expiring loans cannot be rolled over without huge outlays of cash at risk and can only be extended from their current terms at lower rates than refinancing, though still much higher than replacement cost. Thus, we find ourselves in a market where lenders and borrowers are at something of an impasse, as the underlying assets are now worth significantly less. A workout is called for.
Governmental Action
By being proactive, governments at all levels can get ahead of the possible spread of the malaise. Programs should be developed that allow lenders and borrowers to access facilities that, in effect, bridge the chasm between the market today and the market we anticipate in ways that do not simply mark temporary conditions to current market prices and change owners therefore.
Summing Up
Overall, the commercial real estate industry is experiencing an increasingly unsettling trend known as strategic default, due to the discrepancy between the value of commercial properties and their need to refinance maturing debt. In order to lessen the danger of future defaults, lenders and landlords in Los Angeles and New York are taking action as the pandemic continues to bring economic instability. Nonetheless, there are still worries that the market for commercial real estate may continue to be significantly exposed to strategic defaults. Lenders and landlords must continue to be attentive and take the required precautions to protect their investments in order to safeguard the health of the commercial real estate market, and the government must make financial aid available to them so that they may maintain their enterprises.
Other recent articles
Article Search
Share
All Article Categories
