Analysis: 1740 Broadway, Veritas portfolio sales usher in next phase for market recovery 

The pending sale of a defaulted note on 1740 Broadway in New York and the foreclosure sale for a San Francisco multifamily portfolio could be the start of a broader shakeout.   

The pending sale of the note on 1740 Broadway in New York and the foreclosure sale last week of the Veritas San Francisco apartment portfolio could be the start of a series of resolutions for stressed properties and mortgages, according to market participants who have spoken with Real Estate Capital USA. 

Despite a continued slowdown in market activity, these transactions demonstrate lenders, borrowers and servicers are starting to take steps to resolve troubled situations. 

“Whether it’s discounted sales of mortgage notes, or just low sale prices for commercial real estate properties directly, we’re seeing the same in other markets [than New York],” noted Mike Brotschol, managing director and head of KBRA Credit Profile (KCP) division of New York-based data and ratings provider KBRA Analytics. 

Office note sale 

A troubled $308 million commercial mortgage-backed securities loan backed by 1740 Broadway, an office building in midtown Manhattan, got underway this month after several special servicer replacements. 

Midland Loan Services – the current special servicer on the loan – hired Chicago-based advisory JLL to handle the sale. The loan is expected to be sold for a 50 percent discount given the declining valuation of its underlying asset, according to market participants with knowledge of the transaction.  

Analysts said the latest sale plan showed an agreement between the loan’s stakeholders that liquidation is the best or the most efficient approach to maximize the returns for the CMBS trust. 

The loan is being marketed for around $150 million, with the latest reported appraisal of 1740 Broadway set at $175 million in April 2023. Brian Quintrell, director with KCP, noted the pricing gives some upside for whoever will purchase the note to foreclose.  

“It keeps the trust from having to bear the cost of pursuing foreclosure, marketing costs of selling, brokerage costs, and other ancillary expenses,” Quintrell said. 

The valuation also comes down to what the potential bidders are looking at for the property’s highest and best use.  

KBRA Credit Profile’s Brotschol said it remains to be seen what type of interest the sale will receive. There may be buyers hoping to participate in the bidding process, but the note could also not be attractive enough when the underlying property is a vacant office building. 

“There’s also been chatter for this one, that it could be ripe for redevelopment and conversion to multifamily. With occupancy as low as 9 percent, the property owner doesn’t have to contend with buying tenants out of their lease and therefore would have a quicker path to potential redevelopment,” Brotschol added.  

Because there haven’t been many transactions in the market, buyers and sellers are grasping at any data point they can get, so the pricing of the note sale could be looked at as a comp for the market. “Though every asset is unique in its design, structure, quality, and the circumstances surrounding its operation, it’s something you can benchmark against for sure,” Brotschol said.  

Having said that, the unique situation of 1740 Broadway may not mirror the broader office market in New York. 

Stav Gaon, head of securitized products research and strategy at New York-based Academy Securities, said the declining appraisal of the property’s value doesn’t necessarily tell a story about an average New York office. “[This is a] very unusual case where a very prominent sponsor walked away, but that’s just one property in New York. There are hundreds of other office buildings in New York that don’t experience the distress of 1740,” he said. 

Still, the fact that the 1740 Broadway note sale became notable does not dismiss the distress in the office market in some parts of New York City, Gaon said. 

“Will the market really take the valuation of a highly distressed property as the benchmark for the market? My suspicion is that the sophisticated commercial real estate folks would take what’s going over there in context,” he said. 

Workout alternatives 

As stress rises, market participants are turning to old playbooks to find resolutions. These include splitting lots into junior and senior notes, also known as A/B modifications. 

“In the years after 2008, we saw a lot of A/B modifications, where the debt was split into different tranches [during workout processes],” Brotschol noted.  

This bifurcated workout approaches on a single loan are less common today, partly because there’s less confidence in the market right now with where values are, Brotschol said. 

“I think one of the challenges today to consider A/B modifications is figuring out where to cut the debt. The A-note typically aligns with the ‘as is’ value of the property, and that’s harder to define in today’s environment,” he explained.  

Currently, if a property is experiencing dire distress, borrowers can hand back the keys if they’re not interested in owning the asset any longer. The alternative is to negotiate extensions for the loans if there’s potential for the asset to rebound, or lenders believe the loan will pay off eventually in a better rate environment in the future, Brotschol cited. 

Still, there are also challenges to work out the extension option for distressed loans in today’s market. 

“The lender may even encourage an extension because it might be in their best interest to wait until valuations are in a better spot to work out the loan, but you need a committed borrower,” Brotschol said. 

Another challenge is to evaluate whether the property is defendable and supportable and whether an extension would bolster the value and improve the resolution.  

“Every property would benefit from lower interest rates and more stabilized valuations, but some are too far gone,” Brotschol said.  

He added that for some properties, it could be more reasonable to proceed with a short sale, as there may be negative consequences to holding an asset for a longer term. “Maybe you would get a higher disposition price by holding the asset longer, but there’s a cost to get there. That’s the math and the calculations lenders are sorting through,” he said. 

Drive of distress 

Unlike the situation with 1740 Broadway, the sale of the Veritas’ San Francisco apartment portfolio ultimately occurred via a foreclosure. 

One month after acquiring two portfolios of non-performing first mortgages secured by 75 San Francisco rent-controlled multifamily properties, Toronto-based manager Brookfield won the underlying asset via a foreclosure auction. 

In a statement, Brookfield said the transfer was an opportunity to own multifamily portfolios of scale in San Francisco where the assets were “under-managed and under-invested in due to financial difficulties of the prior owners.” 

Academy Securities’ Gaon said when the market starts to see more action in workout situations, it’s crucial to analyze the drive of distress to determine the best approach for a workout. 

“Is it really the elevated rate environment that challenges [the properties’ viabilities] and [the properties] need a low-coupon loan to get refinancing, or is it more fundamental, like it is an obsolete property?” Gaon said. He added it went case by case on whether the solution pertained to a modification, a note sale or a foreclosure sale where the trust essentially takes over the property and becomes the owner as in Brookfield’s case. 

“The fact that we’re seeing all of that does suggest that the market is starting to work through the distress,” Gaon added. 

Additionally, the fact that the market is probably starting to see a more normalized rate environment made it easier for investors to distinguish between notes and properties that may be able to eventually rebound in the right environment, Gaon said. 

“I wouldn’t necessarily say that the uncertainty is clearing out, but there is at least a bit more optimism or constructive thinking about the Federal Reserve’s moves,” he added. 

Outlook 

Ben Tapper, executive managing director at Lee & Associates Commercial Real Estate Services, believes New York’s office market will see challenges. The city’s office market in New York is now “oversupplied and under-demanded,” with excessive stock of older functionally obsolete office properties. 

Other than the lasting impact of the hybrid working model, Tapper sees office demands in major markets like New York have changed by cost-efficient strategies, citing some companies’ decision to relocate their office space to locations where rent and other costs may be lower and human capital easier to hire. 

As a result, “New York is being hit hardest when it comes to aged office assets and space that’s no longer functionally valuable,” he added. 

Still, for investors that see a potential rebound with either the office sector or commercial real estate in the New York market, KBRA Credit Profile’s Quintrell believes there is some long-term upside as the market got to seemingly the end of the rate hike cycle. 

“The $150 million sale on 1740 Broadway comes out to just over $245 per square foot, and that could be attractive to potential buyers willing to ride out the cycle and await improved valuations,” Quintrell said, adding that if the interest of acquiring 1740 Broadway is limited, it leaves a potential for the bidder to further negotiate for a lower price. 

Brotschol also noted other than prominent distressed situations, there is a good portion of the market that is still fairly protected and loans that will still be viable candidates for paying off the maturity. 

“We’re not painting the entire market with a single brush, because we understand there are loans out there that were underwritten and originated with more conservative metrics,” he said. “Despite the rise in interest rates and recent negative impacts on valuation, this cohort of loans may still be on track to refinancing.”