A Mortgage on the Tower of Babel
Tom Acitelli Sept. 22, 2009, 3:37 p.m.
The last two years’ nearly unprecedented economic and labor declines have encroached upon communities across the U.S. Over the past year, unemployment rates have increased in all 50 states and in each of the nation’s 372 metropolitan areas. Coinciding with this pervasive weakness, personal income and spending have slowed in all but a handful of cases.
In the aggregate measures of economic activity, combined falloff in employment, wages, and personal consumption represents the most significant drag to renewed prosperity.
Notwithstanding this broad-based decline in the nation’s local economies, few cities have faced the extent of challenges that has beset New York over the past year. As the center of the financial services industry, New York has faced down unusual short-term challenges as it also grapples with long-term adjustments. The city’s having outpaced many peer markets in the severity of its labor-market decline reflects other sectors’ dependence on financial services and related professions. While finance, insurance and real estate represent roughly one in five of the city’s jobs, professionals employed in these sectors account for a disproportionate share of wages earned and taxes paid. Excluding incentive-based compensation, financial services employees earned 2.9 times the city’s average wage in 2007 and 2008. Including incentive-based compensation, financial service professionals command even higher salaries.
Cascading through the local economy, downturns in the financial services sector impact the demand for all other goods and services, as well as the city and state budgets. Given its keystone role in the local economy, the upending of major private financial institutions—coinciding with the conservatorship of the distantly headquartered government-sponsored enterprises—cast a pall over the city a year ago.
That dour outlook has been brightening, however, as evidence of stabilization in the local economy has emerged from amid the chaos.
Among the most tractable measures, the Federal Reserve Bank of New York’s Index of Coincident Economic Indicators for New York City began to ease in the rate of its decline in January. In each month of this year, the decline in the Coincident Index—which captures current payroll employment, manufacturing activity and real earnings—has moderated.
Even in the hard-hit financial sector, the pace of job losses has slowed markedly since the crisis reached its nadir. According to preliminary data from the Bureau of Labor Statistics, financial services payrolls in the city declined by less than 10,000 jobs between April and August. In comparison, financial services payrolls fell by almost 11,000 jobs during last September alone. On a seasonally adjusted basis, the city has actually registered gains in total employment over the past six months, adding almost 30,000 jobs since March. There has been a marked improvement in office lease signings—a leading indicator of firms’ expectations for their payroll trajectories and ultimate space need—over this same period, albeit at fire sale rents.
OF COURSE, THIS TENTATIVE recovery is far from universal. In particular, New Yorkers who have lost their jobs have invariably found that new opportunities are still limited. According to data released last week by the Bureau of Labor Statistics, job openings have fallen by 50 percent since reaching their peak in June 2007. For many people, the initial recovery is observed but not yet experienced firsthand.
Likewise, serious challenges remain in the offing for many real estate investors, the holding of levered assets foremost among them. Net absorption has not turned positive as of yet. And downward pressure on rents resulting from a surge in sublet availability has invariably hurt lease rollovers’ cash flow. For maturing mortgages, lower appraisals and more conservative underwriting require substantial de-leveraging.
The volume of distressed office sales, in New York and in other major metros, has fallen short of opportunistic investors’ expectations. To general investors outside of the commercial real estate market, the high profiles of recent sales, such as that of Worldwide Plaza, offers the appearance of a more active distressed marketplace. Where banks are holding mortgages, extensions and modifications of existing balances have, to date, been favored over more extreme options.
Following last week’s move to facilitate the modification of some commercial real estate loans included in real estate mortgage investment conduits (REMICs) without tax penalty, a larger number of New York’s securitized office mortgages will go the same route. In both cases, loss severities are increasing in the level of systematic distress.
While New York is indisputably among the most preferred global office investment markets, the aggressiveness of underwriting and lax risk evaluation at the peak of securitization activity is also reflected in its potential for legacy distress. More than one in six office mortgages that are on watch lists nationally are tied to New York City office properties. One in 10 office mortgage dollars in special servicing are similarly tied back to New York. For mortgages above $50 million, New York City accounts for one in four office-watch-list dollars and one in five in special servicing.
The quantitative indicators of distress—vacancy, cash flow, debt service capacity—are easily observed. One part of the equation is fixed: Decisions about initial value and leverage are legacy choices. Ultimately determinative of outcomes, the borrowers’ capacity to manage their properties in a stressed environment and the shared capacity of borrowers and lenders to work together toward solutions offer the degrees of freedom that have the potential to mitigate the market’s legacy albatross.
Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.