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Commercial real estate can't seem to shake these COVID symptoms

The market's 2021 comeback won't save all the properties that remain beset by debt woes caused or exacerbated by the pandemic.

Alby Gallun June 25, 2021 Crain's Chicago Business

The Palmer House Hilton has reopened, but foreclosure looms. Gurnee Mills has won a reprieve from its lenders. The Civic Opera Building is in purgatory.

After a scary 2020 for commercial real estate investors, the fading pandemic and recovering economy are easing their worst fears of a prolonged and painful slump—and wave of foreclosures. But the market's 2021 comeback won't save all of real estate's long-haulers, the properties that remain beset by debt woes caused or exacerbated by COVID-19.

The Chicago-area delinquency rate on a key category of debt, commercial mortgage-backed securities, or CMBS, fell to 11.2 percent in May, according to Trepp, a New York-based research and consulting firm. That's an improvement from the peak of 14.0 percent in June 2020, but it could take years for the rate to return to its pre-COVID level of 2 to 3 percent.

"I don't think we're out of the woods yet," says Tom Fink, senior vice president and managing director at Trepp.

That statement applies to some of the biggest properties contributing to the area's high delinquency rate. The 1,635-room Palmer House, the city's second-largest hotel, reopened June 17 after being closed due to the pandemic for 15 months. But its future remains a question as its owner, New York-based Thor Equities, tries to resolve two foreclosure suits totaling more than $410 million.

Gurnee Mills, the area's third-biggest mall, with about 1.9 million square feet, is in a better spot. After defaulting on about $124 million in CMBS debt last year, the mall's owner, Indianapolis-based Simon Property Group, negotiated a forbearance agreement with a loan servicer in December, protecting the property from a potential foreclosure suit.

In the West Loop, the owner of the Civic Opera building, Nanuet, N.Y.-based Berkley Properties, also is trying to work out a forbearance agreement after stopping payments on about $164 million in CMBS debt, according to public securities filings. Foreclosure is a still possibility.

The properties represent the three real estate sectors—hotel, retail and office—hit hardest by the pandemic.

Hotels suffered massive losses last year as business and leisure travel came to a halt and occupancies plunged.

The CMBS delinquency rate for Chicago-area hotels jumped to 57.1 percent in October, largely due to the Palmer House's troubles, and has declined only slightly since then, to 55 percent in May, according to Trepp. Local hotels with delinquent CMBS debt include the W Chicago City Center, the Marriott Chicago River North and the Hilton Orrington Evanston.

A rebound in tourist and business travel could lift many hotels out of the danger zone. The owners of some, like the Godfrey in River North, have already worked out loan modifications.

But lenders, after being patient with delinquent hotel owners during the pandemic, also could start demanding that borrowers do more to recapitalize their properties now that the market's improving, says attorney David Neff, a partner at Perkins Coie who specializes in hotel bankruptcies and restructurings. If a hotel owner asks a lender to forgive some of its debt, the lender will require the borrower to invest more equity in the property, he said.

"I think you're going to see lenders get more aggressive," says Neff, who represents lender Wells Fargo in one of the foreclosure suits against the Palmer House.

Though he wouldn't make any predictions about the Loop hotel's fate, Neff says the hotel's reopening is a positive step. A Thor spokeswoman declines to discuss the suits but says Thor "looks forward to a lively summer" at the hotel.

The recovering economy also is a good sign for retail landlords, which were crushed last yearas retailers went bankrupt, closed stores or stopped paying their rent. The CMBS delinquency rate for Chicago-area retail properties rose as high as 29.6 percent in August, according to Trepp.

In an encouraging sign, retail delinquencies dropped to 11.9 percent in May. Owners of some big properties, like Yorktown Center in Lombard and North Riverside Park Mall, have negotiated loan modifications and averted foreclosure. Rather than seizing a big mall and bringing in another firm to fix it, many loan servicers and lenders would rather work out a deal with a mall owner that has the expertise to turn it around.

"People are trying to be rational about what they're doing, because the alternative is to be a hard-ass and take a loss," Fink says.

Still, the long-term outlook for retail is anything but bright. For many housebound consumers, the pandemic merely reinforced the convenience of online shopping, which had been taking big bites out of the brick-and-mortar retail sector for years. Though shoppers are returning to stores, e-commerce will remain a growing threat to shopping malls and other properties, one reason to expect more distress in the future.

The future is uncertain for the office market, too. The CMBS delinquency rate for local office properties has edged up but is still relatively low, just 3.8 percent in May. The question is what happens in the coming years: Will demand for office space decline as more professionals work from home in the post-pandemic era? No one knows right now, but Fink is bracing for higher delinquencies.

"Office is going to be a slow burn," he says.

Just one big downtown property, a 487,000-square-foot office building at 401 S. State St., fell into foreclosure last year, and its owner handed the building over to its lender. Rialto Capital, the loan servicer overseeing the Civic Opera Building, has not ruled out a foreclosure suit against the 915,000-square-foot tower at 20 N. Wacker Drive, according to public filings.

Though Berkley, the owner of the Civic Opera Building, stopped making mortgage payments, the property's problems are mostly temporary, says Brian Whiting, president of Chicago-based Telos Group, the building's leasing agent. Two co-working tenants, Bond Collective and TechNexus, had a hard time making rent payments as people stopped coming into the office, but their business is coming back, Whiting says. He's confident Berkley will be able to work out an agreement with Rialto.

"There are amicable discussions going on between the lender and the landlord," he says.

Investors that seek out distressed properties could find some compelling opportunities in the future. The volume of distressed deals has been pretty low so far, but it's still early, says Jim Costello, senior vice president at Real Capital Analytics, a New York-based research and consulting firm.

But the deals will require different skills than those employed after the recession of 2008-09, he says. Many properties that ran into trouble then suffered from financial distress: They were simply carrying too much debt that financial pros restructured.

This time around, more properties are suffering from operational distress—not enough cash flow. It takes a different person to solve those problems, Costello says.

"It's not the financial sharpshooter," he says. "It's the people who understand the cost of rebar."

Homeowners get clobbered by county property tax appeals board

The Board of Review has largely reversed moves by the Cook County assessor to shift the tax burden from homeowners to businesses. So says a new report from the assessor himself.

Gerg Hinz January 05, 2021 Crain's Chicago Business

An effort to shift much of the property tax burden in Cook County’s north and northwest suburbs from homeowners to commercial properties was largely undone by the Board of Review, a new report issued by Cook County Assessor Fritz Kaegi asserts.

The report says billions of dollars in higher assessments that Kaegi wanted to impose on business properties were nullified by appeals to the board, which legally has the power to overrule Kaegi. That means the taxes involved—at least tens of millions of dollars a year—instead will be paid by homeowners, not apartment developers, shopping mall operators and the like.

An effort to shift much of the property tax burden in Cook County’s north and northwest suburbs from homeowners to commercial properties was largely undone by the Board of Review, a new report issued by Cook County Assessor Fritz Kaegi asserts.

The report says billions of dollars in higher assessments that Kaegi wanted to impose on business properties were nullified by appeals to the board, which legally has the power to overrule Kaegi. That means the taxes involved—at least tens of millions of dollars a year—instead will be paid by homeowners, not apartment developers, shopping mall operators and the like.

In every one of the 13 townships, Kaegi proposed to increase the share of the total tax load on commercial properties, usually by at least 6 or 7 percentage points. But in every township, most of that was reversed.

In Barrington Township, for instance, Kaegi proposed to increase the share of non-residential properties collectively from 34 percent of the total to 51 percent, a shift of $217 million. But the board reversed the shift and cut another $3 million.

Similarly, in Evanston, the commercial share of valuation went from $600 million (40 percent) proposed by Kaegi to $402 million, or 32 percent, by the board.

In Schaumburg Township, Kaegi’s proposed $1.32 billion in proposed non-residential assessments became $942 million.

Overall, according to Kaegi’s office, the $10.17 billion in property valuations Kaegi proposed for non-residential properties was reduced to $7.19 billion, a reduction of about $3 billion. That means the actual tax bills will have to be levied on the remaining valuation, most of it “residential property owners,” according to Kaegi spokesman Scott Smith. The board’s action “significantly reduced the potential tax burden on commercial owners,” Smith added.

Neither Smith nor the report itself takes a direct shot at the board. Smith said Kaegi was releasing the report because taxpayers have a right to transparency. Kaegi has one view of what commercial property is worth, but the board “saw it differently,” Smith said.

Michael Cabonargi, one of two Democrats on the three-person board, said the report "continues to show how significantly runaway assessments increase property taxes. . . .Predictably, many property owners were concerned and appealed their property taxes because they are seeking relief, and because it is their right. We believe and support taxpayers in their right to appeal their property tax assessment—and to make sure they pay their fair share, and not a penny more. . . .We will never shy away from being an open and transparent avenue for taxpayers to seek a fair review of their assessments and to obtain property tax relief."

Smith said Kaegi attempted to use actual market values as much as possible in reaching proposed assessments, but the board takes other factors into account, including the actual tax load.

Says the report itself: “The office revised its approach . . . in order to better reflect what buyers and sellers experienced in the market. The office believes its approach is more accurate than its past approach and more closely tracks the market.”

Some commercial owners have argued the market can and does fluctuate from year to year, and a property ought to be valued on how much value it can spin off.

Single-family home and small apartment-building owners already get a tax break, with their property supposed to be assessed at 10 percent of its market value. Commercial property, including large apartment buildings, are assessed at 25 percent of market value.

Virus Siphons $2.5 Billion in N.Y.C. Property Tax Revenue

The value of office buildings and hotel properties, which have all but emptied out since the pandemic began, is expected to take a nosedive.

By Dana Rubinstein and Jesse McKinley Jan. 14, 2021 New York Times

As New York City officials fight to control the coronavirus by this summer, it is becoming clear that the economic fallout will last far longer: The city’s property tax revenues are projected to decline by $2.5 billion next year, the largest such drop in at least three decades.

The anticipated shortfall, which Mayor Bill de Blasio announced on Thursday, is largely driven by a sharp decline in the value of office buildings and hotel properties, which have all but emptied out since the pandemic began.

City Hall officials said that the market value of the tax class that includes hotel, retail and office properties has fallen by 15.8 percent, putting the city’s budget in a precarious position for the foreseeable future: Roughly half of the city’s tax revenue comes from real estate.

For now, the city will partially offset the loss with increased revenues from income taxes: The “rich got richer,” according to a slide from the mayor’s presentation.

But the city will still have to substantially cut spending, although officials gave no clear indication what services might be at risk. Mr. de Blasio said that since last January, the city had already cut 7,000 jobs through attrition and a hiring freeze; he now plans to reduce the city’s head count by another 5,000.

“This is just a total economic dislocation for certain industries,” the mayor said. “We’ve never seen anything like what’s happened to the hotel industry. We’ve never seen Midtown in the situation it is now.”

New York has been devastated by the pandemic’s dual paths of destruction: The virus has killed nearly 26,000 people in the city, while hundreds of thousands of jobs and billions of dollars in tax revenue have been lost.

At the height of the pandemic, unemployment exceeded 20 percent; today, a half million New Yorkers remain unemployed. And although some businesses remain open, many workers are staying at home rather than using mass transit to commute to densely packed office buildings in Midtown and Lower Manhattan.

Mr. de Blasio and Gov. Andrew M. Cuomo, who have battled with the Trump administration for more federal aid, have expressed optimism that President-elect Joseph R. Biden Jr., together with a Democratic-led Congress, will bring substantial assistance.

Indeed, just before Mr. de Blasio’s announcement, the incoming Senate majority leader, Chuck Schumer, said that he and Mr. Biden had reached a deal for the federal government to cover the full cost of state and city expenses related to a disaster declaration from last March, when the virus was first discovered in New York. The city had been on the hook for 25 percent of the expenses eligible for federal emergency reimbursement.

The move is expected to save the state and city about $2 billion, money that Mr. Schumer’s office said can be used to “tackle Covid-related budget gaps.”

On Thursday, Mr. Schumer was promising more to come.

“This is just prelude of better days ahead out of Washington for New York,” he said. “With Biden as president and me as majority leader, it’s going to get better.”

A $1.9 trillion proposal unveiled on Thursday by the president-elect contains $350 billion to help state and local governments. Still, few expect the federal government to be able to fully meet their budgetary needs, especially with the economy in such flux.

In November, the city projected that the budget for the next fiscal year, which starts in July, would include $31.8 billion in property tax revenue. On Thursday, the city said it was recalibrating those expectations downward by $2.5 billion.

“This is an unprecedented drop,” said Thomas P. DiNapoli, the New York State comptroller. “We have not seen property tax collections decline in more than 20 years and never at these levels.”

Even if normal economic activity resumes in New York City, it will not necessarily result in the full-scale return of office workers to office buildings, now that so many have become acclimated to working from home.

In early January, only 29 percent of Manhattan hotel rooms were occupied, compared with 69 percent the year prior. More than 230 Manhattan hotels have closed, at least temporarily, during the pandemic.

The Manhattan retail sector, which was getting battered by e-commerce before the pandemic set in, continues to suffer, too, with rents declining and vacant storefronts increasing.

In 2020, tenants leased just 20.5 million square feet of office space in Manhattan, the lowest level in at least 20 years, according to a recent report from Savills, a real estate services firm.

It “will still be several quarters before workers return to the office in earnest and the full implication of demand shifts due to work-from-home or new location strategies can be seen,” notes the recent Savills report.

Landlords have responded by embracing unconventional ideas, like converting large swaths of underutilized Midtown office space into apartments, a notion recently embraced by Mr. Cuomo.

The agreement with the Biden administration to pay 100 percent of coronavirus-related emergency expenses — similar to one that New York had with the Obama administration in the wake of Superstorm Sandy — will mean about $1 billion for the state and the city each, Mr. Schumer said.

The Trump administration had previously committed to such an arrangement, the senator said, but had never actually acted on it, leaving the city and state to cover 25 percent of those costs.

“I asked Trump for this personally two or three times,” Mr. Schumer said. “He said yes, and he never did it.”

Thanks to the arrival of more aid, the city will be able to put off nearly $200 million in cuts to education funding, including a $44 million cut to the expansion of the mayor’s “3-K for All” preschool program.

Earlier this week, Mr. Cuomo announced that the state government was facing a $15 billion shortfall, which he characterized as the largest in state history, something he, too, said he hoped the federal government would help backfill.

“We expect basic fairness from Washington,” he said on Monday. “Finally.”

Mr. Schumer said he had spoken to the president-elect and Nancy Pelosi, the speaker of the House, about the need for direct aid to state and local governments — something that was left out of a December coronavirus relief bill — and both leaders were committed to providing it.

But as to whether it means a complete bailout for New York, Mr. Schumer was more circumspect.

“We’re going to do everything we can to get the state all the money it needs,” he said.

Kaegi jacks up assessments on south suburban landlords

Owners of commercial properties in the south and west suburbs of Cook County could face higher property tax bills next year. But homeowners will bear less of the burden.

Alby Gallun November 5, 2020 Crain's Chicago Business

After jacking up assessments on commercial properties in the northern Chicago suburbs in 2019, Cook County Assessor Fritz Kaegi has delivered a repeat performance south and west of the city this year.

Kaegi’s office assessed all nonresidential property in the south and west Cook suburbs at $5.25 billion, up 56 percent from 2019, according to data from the assessor’s office. The total assessed value of residential real estate in the suburbs rose 8 percent, to $8.42 billion.

The figures underscore the major shift underway in the Cook County property tax system under Kaegi, who set out to reform the office and improve the accuracy and transparency of its assessment process after he was elected in 2018. He has hit office buildings and other commercial properties with big assessment hikes, drawing criticism from landlords and property tax appeals attorneys that he’s trying to redistribute the county’s wealth by shifting the tax burden onto them.

Landlords in south and west suburban Cook County most definitely will shoulder more of the tax load next year, when they receive tax bills based on the 2020 reassessment. The new valuations mean nonresidential properties now account for 38 percent of the total assessed value in the area, which stretches from Oak Park to Sauk Village, up from 30 percent last year, according to the assessor’s office.

That’s good news for homeowners there, many who pay excessively high taxesrelative to the value of their properties. Residential properties now make up 62 percent of the assessed value in the area, down from 70 percent last year.

Assessed values would have risen more if it weren’t for the coronavirus pandemic. As the virus swept into the Chicago area, Kaegi’s office set out to account for it in the assessment process, assuming it depressed the values of many properties. In Berwyn Township, for instance, the assessor lowered values on single-family homes and condominiums by 9.6 percent to 11.3 percent because of COVID-19.

Kaegi is in the second year of a three-year reassessment cycle in Cook County, an often opaque process that determines who pays what in property taxes used to fund schools, police and fire departments and other local government functions. His office assessed the north and northwestern suburbs last year and will tackle the city of Chicago in 2021.

Higher assessments don’t automatically result in higher property taxes. What matters is the relative change in assessed value. If a single-family homeowner’s assessment rises, but everyone else in the neighborhood receives a bigger increase, the homeowner’s tax bill would likely decline.

Taxes also depend on the levy: how much local governments decide they need to collect in property taxes to fund their operations.

Kaegi has irked landlords mainly with his use of a common real estate valuation metric called a capitalization, or cap, rate. He contends his predecessor, Joseph Berrios, used unreasonably high cap rates, resulting in especially low, and unfair, assessments of office and apartment buildings, shopping centers, hotels and warehouses.

Kaegi says his office uses lower cap rates that more accurately reflect true—and in many cases, much higher—market values.

“I’m not a sadist. It doesn’t give me pleasure to do that,” he said. But he’s “correcting for substandard procedures from previous administrations.”

Nonetheless, the correction resulted in tax hikes for commercial landlords in the northern suburbs. Kaegi’s office boosted total commercial assessed values in the northern suburbs by 77 percent last year, versus a 14 percent increase for residential. After the Cook County Board of Review acted on property owners' appeals of their assessments, total commercial assessed values rose by a smaller amount, 25 percent, as did residential, increasing 11 percent.

But many north suburban landlords suffered sticker shock when they received their tax bills earlier this year: The average commercial and industrial tax bill rose 15.8 percent, while the average residential bill rose 1.1 percent, according to the Cook County treasurer.

Landlords in the south and west suburbs won’t receive tax bills based on their new assessments until next year, but some could be in for some hefty increases. In Orland Park, Kaegi’s office valued the Orland Square Mall at $227 million, more than double its previous value of $110 million. The assessor’s estimated value of Oak Park Place, a 204-unit apartment building in downtown Oak Park, rose 85 percent, to $36 million.

Representatives of Indianapolis-based Simon Property Group, which owns Orland Square, and Oak Park Place owner John Hancock Real Estate, a unit of Toronto-based Manulife Financial, did not respond to requests for comment.

Vacancy Climbs As Rents Fall Across Asset Classes

Most metros are seeing “bleak” fundamentals in apartments, office and retail, according to a new Moody’s Analytics.

By: Kelsi Maree Borland January 11, 2021 GlobeSt.com

Apartments, office and retail are all following a similar trend: rising vacancy rates with declining rents. A new report from Moody’s Analytics calls the dynamic “bleak, but not dire,” noting that while most metros are following a similar pattern, most of the declining fundamentals are more moderate than originally expected.

The national apartment vacancy rate climbed to 5.2% in the fourth quarter, up nominally from 5.1% in the third quarter and 4.7% in the fourth quarter 2019. Apartment rents fell an additional 1.4% in the fourth quarter and are down 3.1% for the year. Major metros are bearing the brunt of the damage. Boston, Washington DC, San Jose, New York City and San Francisco had the most significant decline in apartment rents in the fourth quarter. New York and San Francisco are leading the pack with rents down 12.2% and 14.9%, respectively, for the year.

The national office vacancy rate climbed to 17.7% in the fourth quarter, up from 17.4% in the third quarter and 16.8% a year ago. Office rents have been slower to decline, falling .6% in the fourth quarter and only .7% for the year. Like apartments, New York City and San Francisco led in declining fundamentals with rents falling 1.9% and 1.5%, respectively. However, Orange County, California had the steepest declines in office rents, down 2.3% for the quarter alone. The report found the vacancy rate increases more concerning, noting that 54 markets had an increasing vacancy rate and 26 metros have a vacancy rate higher than 20%.

Of course, retail has been among the hardest hit commercial real estate sectors; however, fundamentals have not deteriorated more significantly than apartments of office. Retail vacancy increased to 10.5% at the end of the year, up from 10.4% in third quarter and 10.2% last year. Rents were down .4% for the quarter and 1.2% for the year. Of the 77 metros Moody’s reviews, 64 markets had a decline effective rent in the quarter.

It isn’t all bad news. Select markets had improving fundamentals this year. In apartments, some secondary markets—Chattanooga, Las Vegas, Sacramento, Ventura County, Memphis and Fairfield County—had effective rent growth of 0.7% to 1.1%. In office, five markets had an increase in effective rents, including Lexington, Raleigh-Durham, Tulsa, Milwaukee and Buffalo. Retail is perhaps the most impressive with 13 metros seeing rising rents, although the growth was moderate.

Unfortunately, Moody’s doesn’t have a better outlook for 2021. The report expects fundamentals to continue to decline this year, particularly in office and retail where tenants that have been locked into long-term leases have not yet had the opportunity to downsize or vacate the property.

COVID Forces Texas Mall Closing

As a recent study shows the dangers of indoor gatherings, more shutdowns

could be on the horizon.

By Les Shaver November 12, 2020 Globest.com

Spiking COVID-19 cases in Texas have forced Simon Property to close the Cielo Vista Mall in El Paso, Texas, according to CNBC.

As Coronavirus cases rise around the country, many other mall operators could be following Simon’s lead, which could mean a second round of COVID shutdowns after the initial wave last Spring.

Right now, Cielo Vista Mall is Simon’s only property that is closed. CEO David Simon told CNBC that he thought enclosed malls were being treated “unfairly and inconsistently,” and there wasn’t sufficient proof that the mall environment “spreads anything.”

However, a recent study published in the journal Nature, found that restaurants, gyms and indoor venues accounted for 8 in 10 new infections from March to May in 10 cities, according to The New York Times. The study showed that less affluent areas were harder hit by COVID because the public venues in those areas were more crowded than in affluent areas. It also indicated that setting caps on the number of people in a facility could help slow the disease’s spread.

Before shutting down Cielo Vista Mall in El Paso, all of Simon’s malls had been open since Oct. 7. During Q3, seven of its retail properties in California were temporarily closed on July 15 due to a governmental order. Six of the properties reopened on Aug. 31.

As of Sept. 30, 2020, Simon’s occupancy was 91.4%, and its base minimum rent per square foot was $56.13, which was an increase of 2.9% year-over-year.

While Simon and enclosed mall owners have struggled with shutdowns, open-air retail has generally remained open throughout the pandemic.

“In open-air centers in many jurisdictions, retailers are currently generally permitted to operate with in-store shopping, although subject to some conditions aimed at limiting congestion and high customer traffic within the store,” Scott Grossfeld, a partner at Cox, Castle & Nicholson, told GlobeSt.com in an earlier interview.

Landlords and retailers in enclosed retail spaces have tried to compensate by offering curbside and other pick-up services, according to Grossfeld. “Although such options provide retailers with some element of economic relief, they, unfortunately, are not the same [or as good] as providing in-store shopping,” he told GlobeSt.com