New York City trophy buildings top list of new debt placed on downgrade watch

By Joy Wiltermuth

SL Green's 280 Park Avenue tops a new list of trophy properties with debt placed on downgrade watch Tuesday by KBRA

A handful of New York City's trophy office buildings were placed on a list for potential debt downgrades Tuesday by bond-rating firm KBRA, as higher borrowing costs, falling property prices and painful vacancies take a toll on commercial real estate.

SL Green's 280 Park Avenue Class A office skyscraper in the Grand Central corridor in midtown Manhattan was the first property financing on the list of 12 transactions on review for potential downgrades.

Unexpected downgrades can trigger forced selling in the bond market, because some investors are required to only hold assets in their portfolios with high credit ratings. A rash of subprime bond funds at investment banks were hit with bond downgrades in the run-up to the 2008 financial crisis, triggering a major liquidity crunch.

SL Green Realty Corp. (SLG), one of Manhattan's largest private office landlords, owes almost $1.1 billion in floating-rate debt on the roughly 60-year-old tower, which has a final maturity date in 2028, according to KBRA.

"Just last month we successfully reduced and extended the debt on the property at favorable terms, reflecting continued confidence in this terrific property," said Steven Durels, director of leasing and real property at SL Green, in an email to MarketWatch. He also noted the property's prime location, blue-chip tenants and a recently expanded lease with private-equity firm Antares Capital.

Other Park Avenue properties subject to downgrade watch by KBRA include $670 million of floating-rate debt on the famed 34-story Helmsley Building, also near Grand Central.

"Buffeted by weak demand, rising vacancies, lower valuations and high interest rates, the office sector continues to face strong headwinds," KBRA said Tuesday. "Uncertainty about future office demand remains high, with the prevalence of hybrid and remote work and many tenants rethinking their space requirements."

Related (February 2023): Losing the trophy? A $45 billion mortgage bill is coming due for some of America's signature commercial properties.

Other properties with debt subject to Tuesday's downgrade watch are listed below.

Office buildings in April saw prices drop 37% from peak March 2022 levels, according to Green Street's commercial-property price index, while the overall sector saw a 21% decline. Landlords also face billions of dollars of debt coming due as the Federal Reserve keeps interest rates high to put downward pressure on prices.

Read: Commercial real estate faces a 'slow-moving train wreck.' Here are the fixes lawmakers could make.

The bulk of the debt financed in the commercial mortgage-backed securities market in recent decades initially earned top AAA credit ratings. Smaller slices of the transactions were rated AA to as low as BB, the first category designated as "junk" or "high-yield."

But with office vacancies in many big cities at record highs and buildings' cash flows under pressure as tenants shrink their footprints, the sector already saw an earlier wave of credit downgrades.

"From my perspective, the rating agencies have to do something to cover themselves," said Liza Crawford, co-head of global securitized products at TCW, pointing to a need to re-evaluate cash flows and valuations for a higher-for-longer rate backdrop, especially with the recent pickup in distressed office-loan sales.

Debt on some distressed office buildings has traded at a 50% discount.

While Crawford doesn't anticipate shock waves from slashed ratings, she has seen some proactive selling from insurance companies of lower-rated debt "to get ahead of ratings downgrades."

KBRA said it would look to resolve or update its watch list within 90 days. The firm noted that the special servicing rate, a gauge of problematic debt, reached 11.5% in April on bond deals it rated. "KBRA anticipates a higher office delinquency rate and more transfers to special servicing of loans secured by certain office properties over the next 18-24 months," it said.

Also read: Here's the investor playbook for making money in commercial real estate as Fed delays rate cuts

-Joy Wiltermuth

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

05-21-24 1748ET

Copyright (c) 2024 Dow Jones & Company, Inc.