Brookfield Properties has defaulted on a $161.4 million commercial mortgage-backed securities loan backing a portfolio of class B office properties after running out of extension options on the 2018 financing.
The loan was transferred to special servicing after the Toronto-based manager executed three one-year extension options on the loan, securitized in MSC 2018-BOP, ahead of an August maturity date. Additional extensions are possible but would require a modification of the loan documents, said Mike Brotschol, managing director and co-head of KBRA Credit Profile Division of KBRA Analytics.
“To secure another [loan] extension, Brookfield would likely need to obtain a replacement cap agreement, and those agreements are very expensive right now,” Brotschol said. He added, however, an extension scenario could work out if rates fall and property cash flows rebound.
The deal had an original balance of $223.4 million at securitization and was backed by 12 office properties that were primarily concentrated in the Washington, DC metro area, with additional assets located across Maryland, Virginia, Florida and Georgia.
According to New York-based data provider Trepp, the loan was underwritten with an occupancy rate of 79 percent. But at year-end 2022, the occupancy level was down to 52 percent, reflecting the long-term impact of work from home policies that started during the covid-19 pandemic.
This metric reflects a bigger picture story around the portfolio, with Brotschol noting the office market has changed substantially in the wake of the covid-19 pandemic. “For loans originated pre-pandemic, those lenders and borrowers were not anticipating a systemic shift in the office market,” he said.
In an email, a Brookfield spokesperson said, “While the pandemic has posed challenges to traditional office in some parts of the US market, this represents a very small percentage of our portfolio.”
The profile of the MSC 2018-BOP portfolio is very different from a February default by subsidiary Brookfield DTLA Fund Office Trust Investor on a pair of Los Angeles offices. The subsidiary owns and manages a portfolio of high-quality LA office properties and did not exercise an option to extend a $465 million loan on Gas Company Tower at maturity, which constituted an event of default. The fund also defaulted on a $318.6 million loan on 777 Tower, another downtown LA trophy office property, at the same time.
What is happening within MSC 2018-BOP portfolio is also different, with Brotschol noting the default came after Brookfield sold three of the properties that made up the deal. These assets were sold above their appraised value at securitization, with Brotschol citing a specific example of one property that was sold for $345 per square foot versus an appraised value of $239 in 2018.
With these sales, the properties were released from the deal and created about $41 million of principal paydown for the senior mortgage. The $20 million curtailments occurred in conjunction with two of the three property releases and additional paydowns were made to comply with debt yield hurdles outlined in loan documents.
“With those releases, the borrower was required to pay down the loan, which they did,” said Brotschol. “It seems they did release some of the stronger-performing properties.”
Brotschol said with the increasing costs of borrowing and decreasing property cash flows and values, it’s less likely Brookfield will be incentivized to remain committed to this portfolio. There are some solutions, including a sale of the mortgage notes, foreclosure or structuring an A/B modification to divide the senior mortgage into two components and extending its maturity. In this scenario, the senior part of the mortgage will receive payment until the end of the term while the junior component receives a potential equity return.
“If there’s a default on the mezzanine debt, the mezzanine lender can foreclosure on the borrower’s equity position and step in as the mortgage borrower,” Brotschol added. In other situations, he added, borrowers have offered a pledge of equity as collateral to facilitate modification negotiations of senior mortgage positions. With current market conditions, lenders and special servicers have been forced to consider more creative modification solutions to work out distressed mortgages.
Outlook on office
With interest rates remaining high and occupancy rates low, analysts are expecting to see further bifurcation within the office sector in terms of performance.
“I do still think there are some advantages to being the owner of a Class A building versus Class B, or C, but those advantages are dissipating,” said Brotschol.
As tenants have asked for lower rents to lease office space, it has become harder for owners to complete leases. Even if the asking rates of some office properties are in line with the pre-pandemic level in certain markets, when factoring in rent concessions or discounts, operators may end up with an effective rent that is oftentimes much lower than their initial quoting.
“It’s going to be a correction. With this amount of vacancy, it’s going to impact property values. When the dust settles and markets normalize, I think future financing will perform better,” Brotschol said.