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One of New York’s biggest property developers is launching a $1bn fund to invest in the city’s distressed office buildings, potentially heralding a new phase in the commercial real estate crisis.
Scott Rechler, the chief executive of RXR Realty, one of New York’s largest office landlords, is teaming up with Ares Management, an alternative investment manager that has $49bn in real estate assets.
The partners are convinced that a prolonged paralysis in an office market frozen by uncertainty about interest rates and the threat of remote working is now breaking, with many players ready to accept losses to unload or restructure assets.
“We have clarity as to where rates are, we have clarity about the future of offices, and which buildings are going to be competitive, and we have a capitulation, I think, to a recognition that values aren’t just bouncing back like they did in ‘08,” said Rechler. “There’s a reset and that this is more permanent.”
Leasing activity for US offices picked up in the fourth quarter of 2023, with several large deals announced, also contributing to expectations that activity was resuming in the market after an extended pause.
RXR and Ares are planning to target a sliver of office buildings around the city that they believe are still appealing but that may need fresh capital to remain competitive or a restructuring of their debts to reflect the new realities of higher interest rates and slower — or non-existent — rent growth.
In what many are now calling a trifurcated market, those buildings rank below the newest and most modern towers, which are still fetching record rents, but above a growing list of older offices that are fast becoming obsolete.
“Where we’re seeing the best opportunity is to buy the upper quartile of that middle, class-A part of the market,” Rechler said, arguing that many of those properties had been shunned by lenders and investors desperate to exit the sector altogether. “If you’re able to be almost a stockpicker, you can buy real value at these prices.”
Craig Snyder, an Ares partner, said that “the broad, indiscriminate flight of institutional capital from the office sector has resulted in many high-quality properties trading down to historic lows,” and that the partnership was “hoping to identify long-term winners”.
Other developers have also been hatching plans to buy distressed office buildings and related debt but have, until now, been frustrated by a lack of willing sellers.
Identifying good buildings is an unproven art. One essential is their proximity to public transit. The partners are also measuring mobile phone data, retail activity and other indicators to try to sift the good from the bad.
Rechler is the scion of a Long Island real estate family. He was proved prescient during the 2008 financial crisis, selling his company in 2007 and then returning to the market in 2009 to buy about $4.5bn in offices over the next two years. Those towers rebounded quickly after the crisis passed, and then soared in value.
This time is different, he believes: it is not a question of the wider financial system seizing up or a lack of liquidity. Rather, the offices themselves are the problem because remote working has reduced demand for space. The sharp rise in interest rates that began in 2022 compounded the challenge for their owners, who needed to refinance loans they took at historically low rates.
Some $117bn in commercial mortgages tied to US offices will come due this year, according to data from the Mortgage Bankers Association, part of a wall of looming maturities that is contributing to expectations of distressed sales. A broader measure by Trepp forecasts $2.2tn in commercial real estate debt maturing over the next three years.
Banks have been keen to shed their exposure to commercial real estate, in part under pressure from regulators after several regional lenders collapsed last year. Many investors have also shied away.
As a result, office owners have been left with few options to refinance loans coming due or find new capital to pay for improvements necessary to lease their properties. Some — including RXR — have responded by simply handing the keys back to lenders for buildings whose debts may now exceed their value.
Ares has shown a willingness to step in where lenders have pulled back. Last year it bought a $3.5bn loan portfolio from PacWest Bancorp, which was then desperate to raise liquidity.
Together with RXR, it has seeded the new fund with $500mn. The partners are hoping to raise at least an additional $500mn.
“We bring capital and operational expertise and an understanding of what’s happening in the leasing market to know where tenants are going,” said Rechler, noting that they were already in negotiations to buy $1bn in office loans from different banks at varying discounts.
Those transactions were playing out behind the scenes. “No one really wants to expose either that they have loans they have concerns about or buildings that can’t fund [improvements] because then tenants stop coming to look at the buildings,” said Rechler. “So this is very quiet.”