JPMorgan today advised investors to avoid commercial real estate debt, a move that could ramp up pressure on landlords who need to refinance their mortgages for industrial space, shopping centers, or office towers.
In the last few days debt investors have started to price in the growing risk of commercial property owners defaulting on obligations as the trade war takes hold and the economy slows. JPMorgan warned in a report Tuesday that more pain is yet to come and “lagging performance is now more likely.”
“In preparation for a now base-case recession…we are downgrading our recommendation on REIT credit to underweight from neutral,” wrote analysts at the bank with $145 billion in commercial real estate loans on its books.
Growing risk in commercial real estate is reflected by rising spreads that measure how much a mortgage yields over a comparable Treasury bond. Since April 1, spreads had widened by about 20 basis points for high-quality commercial mortgages heading into today and by 150 basis points for riskier investment-grade loans. JPMorgan described the changes as “significant.”
Higher spreads mean higher borrowing costs for property owners and make it more difficult to refinance debt.
One firm that got across the finish line was Vici Properties, the Midtown-based owner of Las Vegas casinos and Chelsea Piers, which announced late Monday that it had refinanced $1.3 billion in debt. Vici’s credit rating was raised to investment grade six months ago, but JPMorgan suggested the firm was lucky to get its deal done considering two of its largest tenants, Caesars Entertainment and MGM Resorts International, saw their share prices fall by 30% and 23% respectively during the market’s recent plunge.
“It will be difficult for equity (and credit) investors to ignore the performance of key tenants for long,” the analysts said.
JPMorgan said risks are most acute for owners of warehouse space, because in a recession tenants could seek space in more affordable markets, and a trade war would directly affect the flow of goods. Warehouse space in the boroughs outside Manhattan has been one of the city’s strongest real estate sectors for several years, with a vacancy rate of just 5.5% across 140 million square feet of storage space and another 1.1 million are under construction, according to Cushman & Wakefield. Last October Tesla leased 150,000 square feet of industrial space in an abandoned shopping center in College Point, Queens.
“Industrial [space] is in the eye of the hurricane,” JPMorgan said.
Higher borrowing costs would also spell trouble for those who need to sell properties to pay off debts. The bank singled out Service Properties Trust, a Massachusetts-based REIT that owns more than 200 hotels, including the Sonesta White Plains, and seeks to sell $1.1 billion worth before $1.6 billion in mortgages mature over the next two years.
If there’s a silver lining anywhere, it could be for office-tower owners. In a typical recession occupancy rates fall by five percentage points and rents decline by 15%, but JPMorgan – which is to move into its new Park Avenue tower this year – said such a drop doesn’t seem likely now. That’s because demand for space has already been weak for a long time.
