Grant's Almost Daily

History Rhymes

Trouble Ahead for Real Estate?

An excerpt from a Bloomberg dispatch this morning, headed: “HNA’s $2.2 Billion NYC Tower a Hard Sell Less Than a Year Later.”

Last year, the Chinese conglomerate bought 245 Park Ave., a late-1960s-era building that’s home to JPMorgan Chase & Co., paying one of the highest prices ever for a New York office property. Values have since dropped and HNA faces the challenge of selling a building that’s starting to lose some of its gold-plated tenants and in need of improvements that could cost its new owner more than $1 billion, said Gregory Kraut, managing partner of K Property Group, which considered buying the building and examined it closely.

HNA, among the most prolific dealmakers in recent years, is pulling back after its gorge on trophy properties helped push up New York real estate prices. Now HNA, which used borrowed money to expand and accumulated one of the biggest debt loads in China, is under pressure from the government to liquidate assets. The company has already put about $4 billion of U.S. commercial real estate on the block.

HNA’s Manhattan misadventures recall the experience of another overseas asset-gatherer in a prior heyday: specifically Japan’s Mitsubishi Estate Company, which purchased an 80% stake in Rockefeller Center for $1.4 billion on Oct. 31, 1989.  Upon the consummation of that deal, Jotaro Takagi, president of Mitsubishi Estate, was quoted in the New York Times: “There is no business address in the world that has the same cachet as Rockefeller Center. It is synonymous with excellence. We are making this investment with the objective of continuing this tradition into the 21st century.”  Grant’s duly chimed in, quipping at the conclusion of a Nov. 24, 1989 analysis of the then-slowing real estate market that: “Perhaps Mitsubishi Estate Co. . . . would like to buy the rest of the United States.”

The rest, as they say, is history.  Japan’s Nikkei index made its blow-off highs on New Year’s Eve 1989, the real estate boom ended, as booms do, and the high-priced Rockefeller Center deal floundered. From The New York Times’ 1995 follow-up:

Mitsubishi proposed yesterday afternoon that it plans to pass ownership of the Manhattan property to Rockefeller Center Properties, Inc., the publicly traded real estate investment trust that holds the $1.3 billion mortgage on the center, according to advisers involved in negotiations to bring Rockefeller Center out of bankruptcy protection.

REBUTTAL REBUTTAL

On Mar. 11, the Bank for International Settlements sounded the alarm on the Canadian housing market, warning that America’s northerly neighbor features credit-to-GDP and total debt-service ratios that place the country at elevated risk for a banking crisis. Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce (a.k.a CIBC, CM on the Toronto Stock Exchange and the NYSE) took exception to the findings of the central bankers’ own Swiss bank, writing that:

The [BIS] report itself has multiple warnings to treat its results with ‘considerable caution.’ That seems prudent, based on the BIS’s own track record. Two of the current warning signals look particularly likely to mislead.

The first is a measure tracking the degree to which a country’s ratio of non-financial credit to GDP is above its longer term trend. That is certainly true for Canada, but interest rates are also miles below their longer term levels . . . Moreover, as we always caution, it’s not just how much credit has been issued, but to whom. The U.S. financial crisis was triggered by large debts owed to individual households that didn’t have matching incomes. Mortgage arrears rates in Canada continue to dive.

Interest rates, while up from their summer-2016 nadir, are still low by historical standards, and Canadian mortgages in arrears footed to just 0.24% of the total as of the third quarter of 2017 (the most recently available data), according to the Canada Mortgage and Housing Corporation.  That’s down from 0.28% year-over-year.  However, Canada’s elevated debt levels (household debt topped 170% of disposable income in the fourth quarter, well above the 133% peak seen in the U.S. in 2007) and a pronounced reversal in the formerly red-hot housing market (February prices in Toronto dropped 12.4% year-over-year with active listings nearly tripling) will put to the test Canadian mortgage-holders ability to pay.

Relatively small changes in rates can have a big impact: Recall that most Canadian mortgages are structured as five-year bullets with re-setting maturities, as opposed to the conventional 30-year fixed rate mortgage in the U.S.  In addition, the Office for the Superintendent of Financial Institution’s B-20 regulations, enacted on Jan. 1, require all mortgagors to pass a stress test using the “greater of the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate +2%.” According to the Bank of Canada, 47% of all mortgages are scheduled to reset in the year ending July 2018.

Meanwhile, the interest rate tailwind cited appears to be abating.  The benchmark Canadian five-year mortgage rate has jumped more than 10% from its April lows, and has ticked back above its eight-year average (covering the period in which the Canadian housing boom accelerated).