The aftermath of COVID-19 continues to weigh on Chicago commercial real estate
The Palmer House Hilton has reopened, but the lockdown is looming. Gurnee Mills has obtained a stay from his lenders. The Civic Opera building is in purgatory.
After a frightening 2020 for commercial real estate investors, the fading pandemic and economic recovery are easing their worst fears of a prolonged and painful slump and wave of foreclosures. But the market’s return in 2021 will not save all the long-haul real estate, properties that remain plagued by debt problems caused or exacerbated by COVID-19.
The Chicago area default rate on a key category of debt, commercial mortgage-backed securities, or CMBS, fell to 11.2% in May, according to Trepp, a research and advisory firm based in New York. That’s an improvement from the peak of 14.0% in June 2020, but it could take years for the rate to return to its pre-COVID level of 2-3%.
“I don’t think we’re out of the woods yet,” says Tom Fink, senior vice president and general manager of Trepp.
This statement applies to some of the larger properties contributing to the area’s high delinquency rate. The 1,635-room Palmer House, the city’s second-largest hotel, reopened on 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, attempts to resolve two foreclosure lawsuits totaling more than $ 410 million.
Gurnee Mills, the third largest mall in the area, at around 1.9 million square feet, is in a better location. After defaulting on around $ 124 million in CMBS debt last year, mall owner Indianapolis-based Simon Property Group negotiated a forbearance deal with a loan department in December, protecting the property. of a possible foreclosure lawsuit.
In the West Loop, Civic Opera building owner Berkley Properties, based in Nanuet, New York, is also trying to strike a forbearance deal after halting payments on around $ 164 million in CMBS debt, according to public documents filed. Foreclosure is still a possibility.
The properties represent the three real estate sectors – hotel, retail and office – hardest hit by the pandemic. Hotels suffered massive losses last year as business and leisure travel came to a halt and occupancy rates fell.
The CMBS delinquency rate for Chicago-area hotels jumped to 57.1% in October, largely due to the problems at Palmer House, and has declined only slightly since then, to 55% in May, according to Trepp. Local hotels with past due 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 pull 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, could also begin to demand that borrowers do more to recapitalize their properties now that the market is improving, lawyer David Neff, partner, said. at Perkins Coie, specializing in hotel bankruptcies and restructuring. If a hotel owner asks a lender to write off some of their 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 lawsuits against Palmer House.
While he doesn’t make any predictions about the fate of the Loop Hotel, Neff says the hotel’s reopening is a positive step. A spokeswoman for Thor refuses to discuss the costumes but says Thor is “looking forward to a busy summer” at the hotel.
The economic recovery is also a good sign for retail owners, who were crushed last year when retailers went bankrupt, closed stores or stopped paying rent. The CMBS delinquency rate for commercial properties in the Chicago area reached 29.6% in August, according to Trepp.
Encouragingly, defaults fell to 11.9% in May. The owners of some large properties, like Yorktown Center in Lombard and North Riverside Park Mall, negotiated loan modifications and avoided foreclosure. Rather than taking over a large mall and hiring another company to fix it, many loan departments and lenders prefer to make a deal with a mall owner who has the expertise to turn it around. .
“People try to be rational in what they do, because the alternative is to be tough and take a loss,” says Fink.
Still, the long-term outlook for retail is anything but bright. For many homebound consumers, the pandemic has only added to the convenience of online shopping, which has taken big bites in the physical retail industry for years. Although shoppers are returning to stores, e-commerce will remain a growing threat to malls and other properties, a reason to expect more distress in the future.
The future is also uncertain for the office market. The CMBS default rate for local office buildings increased slightly but remains relatively low, at just 3.8% in May. The question is, what will happen in the years to come: Will the demand for office space decrease as more professionals work from home in the post-pandemic era? No one knows at the moment, but Fink is preparing for more serious delinquencies.
“The office is going to be a slow burn,” he says.
One large downtown property, a 487,000 square foot office building at 401 S. State St., went into foreclosure last year, and its owner turned the building over to his lender. Rialto Capital, the loan manager overseeing the Civic Opera Building, has not ruled out foreclosure action against the 915,000 square foot tower located at 20 N. Wacker Drive, according to public documents.
Although Berkley, the owner of the Civic Opera Building, has stopped making mortgage payments, the property issues are mostly temporary, says Brian Whiting, president of Chicago-based Telos Group, the rental agent for the building. Two roommates, Bond Collective and TechNexus, struggled to pay their rent as people stopped coming to the office, but their business is coming back, Whiting says. He is confident that Berkley will be able to strike a deal with Rialto.
“There are amicable discussions between the lender and the owner,” he says.
Investors looking for distressed properties might find attractive opportunities in the future. The volume of troubled trades has been fairly low so far, but it’s still early days, says Jim Costello, senior vice president of Real Capital Analytics, a New York-based research and advisory firm.
But the deals will require different skills than those employed after the 2008-09 recession, he said. Many properties that ran into trouble then suffered financial hardship – they were simply too much in debt that finance professionals restructured.
This time around, more properties are suffering from operational difficulties – not enough cash flow. It takes a different person to solve these problems, says Costello.
“It’s not the financial sniper,” he said. “These are the people who understand the cost of rebar.