Odd Lots - What Dead Malls Tell Us About the Future of Commercial Real Estate

Episode Date: December 4, 2023

There's been a lot of worry over the future of commercial real estate — especially the outlook for office buildings — in light of higher interest rates and the trend towards work from home. But years ago, Wall Street was worried about a different type of CRE: shopping malls. Back in the 2010s, loans backing malls were souring fast, as customers ordered more online and major anchor tenants (like Sears) shuttered their doors. There were sites such as Deadmalls.com that tracked closures around the country, complete with apocalyptic-looking photos of empty buildings. But of course, while the overall number of shopping malls in the US has dropped, not all of them disappeared. Some have even thrived. So what can the shopping mall experience tell us about the outlook for offices and the broader commercial real estate market? On this episode we speak with Liza Crawford, a long-time CRE veteran and trader of commercial mortgage-backed bonds, who's now co-head of securitized at asset manager TCW.See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, Odd Thoughts on Amazon Music. Hello and welcome to another episode of the All Thoughts podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. Joe, have you ever been to the Highland shopping mall in Austin? Absolutely. That's a debt. Is it still there? That's like the one that's not done well, right? I think it has officially died. Okay, I know exactly. Okay, I just, I know there's a few, and I know exactly which one that is. I have spent time in it multiple times. I was there before it died because I lived there 20 years ago. But when I did, it was pretty quiet overall. Like, it was pretty grim. Yeah, this was sort of a classic Texas mall from what I can gather. Opened in 1971 and then closed for good in 2015. Here's another question. Have you ever been to the domain? Yes. And that one is much more busy. And I'm pretty certain still exists.

Yes. So that one opened in 2007. It is still open. From what I can tell, it's very popular. It's sort of an upscale shopping destination. And these two shopping malls, the reason I bring them up is they kind of stick in my mind as the classic example of what happened to malls in the sort of 2010s. So you had this bifurcation in the market where some of the upscale ones, the ones that had some sort of, I don't know, like, specific offering in terms of entertainment, things like that, did pretty well while the old school

ones, the ones that maybe had big anchor tenants that were no longer as popular, a lot of those went out of business. Totally. I didn't, first of all, I just want to say, I appreciate and didn't realize that this is going to be in Austin, Texas episodes. So thank you for that. Yeah, just for you, Joe. But that did, you know, that crystallizes it perfectly for me because I know those two malls

and I know how different they are. And the Highland Mall was sort of, you know, off a highway, not in a great location. There's the kind of place where it probably had some, you know, fast food Chinese in the food court, probably a place that sold hats, maybe a candle store, something like that, you know, called like Wix. You are actually like vividly bringing to life for me, like the early 2000s American Mall. And then the domain has like, you know, probably a really nice Apple store in it. I don't know for sure. A really nice Apple store and some really nice restaurants, probably like a cool like burrito restaurant and stuff like that. So yeah, I think that's it. That's the story of malls. You nailed it. Yes. And the reason I bring up malls in general is because obviously there's been a lot of discussion about the future of commercial real estate. And malls fit squarely into that category. But also in the context of concerns about stress in the office market in particular. I keep reaching back to malls as the analogy here. So, like, clearly there is a structural issue

happening in the market. But that said, you know, you can have specific properties that do better. You can have specific properties that go out of business completely, like the Highland Mall. And so that bifurcation seems really important to me. And I think, you know, we've never, we've obviously done a handful of office episodes. But it makes sense to think more about this bifurcation because one thing that we've learned, even from talking to various people on the office spaces, they're like, oh, class A is fine. Now that I know what class A is definitely, but they're like, oh, yeah, class A, the really nice new locations, they're fine. It's just that there's a lot of other space that is not what people think of as the modern office building. That's right. There's domains and there's highlands.

I love it. So on this episode, we're going to be digging more. into the office sector and commercial real estate more broadly. And I am very pleased to say that we do indeed have the perfect guest. We're going to be speaking with Liza Crawford. She's a portfolio manager and co-head of Global Securitized over at TCW and a long-time investor in this space, someone who also covered malls for a while in the, I think in the early 2000s or 2010. So we're going to get into all of that with her. Liza, thank you so much for coming on all Thanks so much for having me. I'm so excited to be chatting with y'all today.

Well, we're very excited as well. And you said y'all. So we're really like, we're bringing the Texas theme in this episode. Love it. Are you Texan? I was born in Houston. I went to high school in Dallas. I've moved around a fair bit, though. Awesome. So did I get your career summary broadly correct? A longtime player in the securitized space, including in commercial real estate. So things like commercial mortgage-back bonds, CMBS, stuff like that. And also, you were looking at malls at one point, right? Yeah. So I've always been in Securitized for my career. And I started in 2009, so a pretty exciting time, interned in 2008, particularly exciting as well. And I focused on various areas of securitized. But when I joined TCW, the firm I work at now, I was a commercial mortgage-backed

securities trader. So I dedicated all of my time to commercial real estate research and trading. And to your comment, Tracy, it involved a number of property tours. And years ago, malls were the focus. And it was pretty grim out there for a number of tours. But you guys nailed it on the bifurcation. You can really see that when you're visiting these assets. And you can see it come through in cash flows and sponsor decision making. And then currently at TCW, I'm co-head of global securitized. So now I have the pleasure of looking across the broader, almost $13 trillion dollar securitized market. Joe, can I just say when analysts go on the real life tours of shopping malls or stores in general, that is my all-time favorite research. Like I love the idea of everyone

just like hopping in a car and being like, we're going to look at footfall at this mall. Well, same. And actually, that was going to be my question because I, you know, I remember the Highland mall that Tracy brought up. know the domain. And I do remember, you know, Highland Mall is pretty quiet. But I have to imagine that as a professional, you walk through a mall, I walked through the mall, I just sort of noticed vaguely like, this is quiet, this is busy. What is a professional look at when you're on one of these site tours for a mall and you're like looking at it from a sort of due diligence investment standpoint? What are the things that the pro really notices beyond just, oh, this is kind of quiet?

Yeah. So with respect to the malls, you're looking to see if the atmosphere is inviting. So have sponsors spent any effort to try to add natural light, to try to add seasonal decor? So that's just the natural ambiance. Then you're also looking at the density. So is it populated? Are people walking around? What are people holding? Are they holding bags that they're shopping or are they just kind of hanging out and they're taking advantage of air? conditioning. You're checking out the parking lot to see if there are a number of cars there. And then you're looking at the tenant mix. And this is, you know, you can see the real bifurcation. So I remember just Burlington Co factories would always be crushing it. There'd be so many people in there. And then there'd be areas where you've got your fourth sneaker store and nobody's in any of these properties. Or you'd have another hat store or eyebrow shop that you realize they're probably not paying any rent. They're not really even economic, but they are at least kind of filling space. And then one of the most kind of egregious things you'll see on these property

tours for weaker assets is whole areas that are effectively closed off or there are very explicitly tenant temporary tenants. So army recruiting, for example, polling stations. So you can see a landlord perhaps exploring alternative uses. But as a debt investor, some of it looks like a little bit of a smokescreen to juice occupancy numbers that frankly don't drive value for the asset. Tracy, the last time, this is a fact, the last time I was in the Highland Mall, I know this. I happened to be with my mother-in-law, she was voting. It was a polling location at the mall. So there you go. That was her local place to, and I don't know why we, why we were tagging along. But yes, that is my last memory of the Highland Mall.

I'm so pleased with this anecdote that it's like worked out so perfectly because we didn't actually talk about this before the podcast. But this is great. So just going back to that analogy of the Highland and the domain and its sort of application to the broader commercial real estate market and office properties in particular. I mean, I mentioned that's the mall is the sort of prism that I'm looking at the office space through. but tell us how you're viewing it. Like, how useful is the shopping mall sector as an analogy to stress in the office market right now? It's very helpful as an analogy with respect to bifurcation. One of the mistakes folks can make is paint everything with a broad brush. And I'm sure you, y'all remember plenty of headlines of malls are all dead.

And there were plenty of malls that were on their way to dying, zombie. ugly, irrelevant. There are too many of them, et cetera. So, of course. But there's some malls that continue to drive consumer demand, serve a purpose, be well managed. So that bifurcation trend is very real in the office space now. And would love to get into kind of compare contrast of what, as a debt investor, we look for in the different spaces and the different kind of workouts and evolution of these two property types. But importantly, in office, we're really seeing that bifurcation now. Joe, you mentioned Class A earlier, and even Class A is being reviewed.

And now we have Trophy or Premiere. And, you know, what differentiates Class A from, you know, the actual Trophy Premier? Well, everything that was a newer build maybe 15, 20 years ago was Class A. Anything that maybe had a good view would be Class A. And now Trophy Premier means it's either a more. more recent build, best in class, or a more recent renovation, and it has more than just a good view or location, it has actual amenities to attract tenants, whether that's conference space or an excellent food court or gym, et cetera.

I want to obviously talk more about office and start getting into this, but I just have one detail going back to the mall question. What stood out to you about the existence of a bustling Burlington Coat factory? What was it specific? that that told you because that was the one brand that you identified as a thing. What was that saying to you? Yeah, I think when you're when you're touring malls and it gets really sad, you really get excited about the bright spots. And Burlington Co factory was really that bright spot. And it also signals that there is demand to be identified and, you know, leaned into as a landlord or sponsor. So a lot of these properties needed to be right size from,

square footage for the actual, you know, retail demand. But there's consumer demand in the area and you need to re-tenant your space to meet that demand. And what I'm, you know, see in office as well as you saw in retail is that bifurcation translates into sponsors making a decision. This asset is not core to my portfolio. And I'm planning on walking away from it or, you know, rolling off of it in the coming years. So what is the point? of investing any energy in leasing it up, in making sure our tenants are happy with the location that we are investing in demand drivers

that ultimately help the broader kind of ecosystem of tenants. So instead, you just see the underinvestment so present from walled off areas or these day-to-day tenants or month-month tenants likely not paying any rent. And then the successful consumer demand moving into some of these, some of these retailers, that are actually relevant to the local population. The news doesn't stop on the weekends.

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Watch us on Bloomberg Television. Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. Just going back to what you were saying about trophy properties and some signs of stress even creeping into trophy office building. So, you know, we heard a lot about how important quality is in the office space and that some of the older offices

are probably going to encounter significant troubles in the current cycle. But maybe, maybe the Class A would do okay, and certainly the trophy properties should be doing relatively well. But it is interesting if we're seeing even those start to come under pressure. So I guess I'm curious, like, why that's happening. And then secondly, how much of it is rents versus interest rates going up? Great question. So with respect to why we're seeing that Class A come under pressure, there are two main reasons. one time. You know, something that is Class A doesn't just remain Class A. You can't set it and forget it. You know, you need to continuously invest in that asset and make sure it is designed to meet tenant demands of today. And then two, you had COVID. COVID all of a sudden introduced every CEO, you know, into the conversation of what do we want our employees to benefit from in shared office space. I think we all took it for granted before,

COVID happened. We just showed up to the office and if we had a terrible cubicle, we just went with it. I work on a trade floor. So personal space is lacking. I don't, you know, I don't use an office. I don't have a cubicle. But if I explore other floors of our company, there's just, you know, cubicle on cubicle. And there's a lot left to the imagination. It's not as engaging and you don't always benefit from that shared space communication, et cetera. So TCW is actually a great example. We've upgraded our space. We're moving in a couple weeks to a class A property. We're in what perhaps was once considered Class A now, but it's arguably Class B in dropping quickly. But we're moving into a Class A where you have more natural light, you have brighter colors, you have upgraded

amenities, you have technological improvements and more shared space. So it's, it really is an evolution of meeting tenant demand. And tenant demand is the number one. priority as we're in a tough market for office landlords. They are seeing a net reduction in demand, and they need to be proactive to get the best tenants in their space and build out the amenities and whatnot that they need. And that really is fundamentally the definition between what is trophy and what is a Class A that just keeps falling further down the quality spectrum. So at the same time that they're needing to invest in the properties, I mean, rental income is presumably flat or going down because demand is weakening, but costs are going up in the form of

financing. Yes. So excellent point. With the rate move in the last kind of 18 months, the capital markets have created acute stress for landlords that use financing to own and operate their real estate portfolios. And it's very common. Commercial real estate is a levered asset class. It is sensitive to interest rates. The sponsors that have locked in lower fixed rate debt in 2020, 2020, they're sitting tight, right? They might have a 10-year fixed rate. They've got plenty of time. But other sponsors took out shorter floating rate debt. So they are acutely vulnerable to their rates resetting five and a half points higher. And it is acting as a catalyst. And it is acting as a catalyst for them to accelerate their decision-making of what assets belong in their portfolio,

what assets will make sense long-term, what assets are economic to own, and what assets just don't make sense anymore. So after 10 years of low rates and low growth, the debt markets got very sanguine in both the appraisals they'd accept for office in the lack of differentiation. they demanded from these valuations and sponsor quality, etc. in office. And borrowers or the sponsors, the owner operators that borrow in the capital markets got aggressive with the amount of leverage they felt comfortable with their assets. So to your point, Tracy, that's where we're seeing very quick pivots for some very large sponsors to exit entire office properties. You know, Blackstone and Brookfield are great examples there.

By the way, just going back to what you were saying about light, there was actually a great New York Times article three days ago, November 26th. The NV office can Instagramable design lure young workers backed by Emma Goldberg and Anna Kode. But it's sort of speak to exactly what you're saying, light and everything. And they have, you know, these offices that are featured all, you know, like millennial pink and all that stuff. What else goes into? Joe, I don't know why you don't like millennial pink. You always mention it as like a negative example. I like it. I'm just so tired of it. It was cool. 2013 was like, oh, cool new color. It's everywhere. I was like, oh, my God, 2023 are still around. What else looks like a true? When you, you know, you walk into an office like, okay, this is a trophy asset. What does that look like?

What are some other things that you would expect to see? You'd expect to see very high quality entryways, lobbies, lofty ceilings, you know, ideally like atrium. You would have separate elevator banks for, either different floors or different tenants, a luxury feel, right? You want both your employees to feel really excited and proud and productive when they come to work, but you also want your clients to feel like they're special and that they are working with a really high quality company. And then I mentioned kind of those amenities floors. Other examples include just having

outdoor space, just giving your employees the opportunity to step outside. and get some fresh air, see some greenery. And then I think everyone and, you know, Bloomberg, you guys are leading the charge on it, but everyone wants the snacks, the coffee upgrade. So we've seen, you know, beyond just maybe shared amenities that multiple tenants can enjoy, you've also got more amenity focus on tenants dedicated floor space because people want to be able to take a break and get a nice coffee. We don't have any Instagram walls here at Bloomberg as far as I know. Although actually in the basement, there's a pretty cool art installation that is pretty grammable. But by and large, I do feel like we work at a trophy office here in New York.

Can you, though, just setting aside the sort of more qualitative differences? Like, can you speak to the quantitative differences that you see right now in this sort of trophy, whether it's vacancy rates or cap rates or anything else versus everything else? Yes. And then I think it's important we also talk about. geography and specific city stories. So as it relates to the quantitative differentiation we're seeing for trophy assets it's not uncommon to see post-COVIDs translate into a 10% vacancy. There are some assets that only have a 3% vacancy

whereas a BC or even a weaker Class A had 10% going into COVID currently has a 20, 25% and then some assets are effectively vacant. And that's where you see these distress sales come through. I want to lean into a couple items here. So how do Trophy offices, how are they best able to maintain higher occupancy? It's because they attract high quality tenants and they demand high quality leases from those tenants. They have to pay for it in today's market. So what is a high quality lease? A high quality lease is a 10-year term with no contraction options, termination options. You're trying to avoid volatility in your tenant role. You're trying to avoid

your tenants having too much optionality to walk. And then you're also adding high quality tenants, so you're mitigating the risk that they go bankrupt. So high quality sponsors are very focused on that. I think Essel Green is a public read and they're the largest Manhattan office landlord. They're always highlighting that. They do an excellent job with that. One Vanderbilt is there. trophy asset and it's very evident in that property. What happens in weaker kind of BC offices is the sponsors are on their back feet. They have to accept what tenants are willing to give them. So that typically translates into shorter lease terms. So kind of a two to five year and that creates even more vulnerability to the economic cycle, to tenants downsizing or rotating into another

asset. And it also means that you have a weaker tenant base. You are more exposed to bankruptcies and the need to renegotiate rent lower. WeWorks is a great example of the tenant that nobody really wanted. They were expanding massively for years, but sophisticated landlords made sure they were 2% or less of their revenues to mitigate that risk. Yeah, the WeWork is from a debt investor perspective, they've been, you know, it's a curious story and I don't know how open I can be, but it's very frustrating to see some of their behavior. So on the quantitative side, we should see that bifurcation to continue to play out. And perhaps one of the most stark ways to evidence this is when we see some of these distressed sales. It's still early in distressed sales,

but from a dollar per square foot valuation perspective, you would usually pre-COVID see a thousand per square foot for a trophy class a off a trophy asset in New York City, in San Fran, with the rate move, with the stress in the capital markets, we as debt investors quickly reset to closer to a 500 per square foot implied mark to market valuation. Now, if you're a sponsor with a 10-year fixed-rate mortgage and you have your tenants in there for 10 years, you're insulated from this, you know, period of time. So you don't need to monetize that implied mark-to-market valuation. you can hide it, you know, with various, even with a JV interest sale, you can finagle a way to really preserve that kind of top tick valuation. But for weaker assets, they cannot hide. The sponsors walk

away from them. They hand over the keys to the lender. And the lender gets an updated appraisal that's closer to market and or the lender sells the asset into the market. And that's where you're seeing valuation declines beyond 70%. I mentioned Blackstone walking away from an asset. in New York City, that's 1740 Broadway. It's basically empty. And the valuation was closer to 1,000 per square foot in 2015. They committed over 300 million with that acquisition. And they walked once the largest tenant rolled. And the valuation came in around 300 per square foot, just under the updated appraisal. So it is dire out there. But yeah, so if you are insulated, owning and operating a business using prudent leverage, you can navigate economic cycles.

If you are over levered or overextended or going through your portfolio and exiting the losers, that's where we see kind of these real prints come through and it adds that quantitative data to really ink how far some of these assets can fall. I'm Francine Lacqua, an award-winning journalist, and I've got a new podcast, leaders with Francine Lacroa from Bloomberg podcasts. I've interviewed everyone from heads of state to fashion icons about the news of the moment. But I've always been curious who are these people as leaders. I don't think there's one right way to be a leader.

Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts. So I definitely want to ask you more about the specific. things that go into a decision by a sponsor to walk away from a property or try a workout. But since you mentioned geographies and since a lot of what we're talking about is bifurcation in the market, tell us what you're seeing in different areas. Yeah. So we work in downtown L.A. here at TCW. And the vacancy is 30%. And that seems like a number on a good day. But that's the

official reported number. So there is just too much supply for limited demand. And there is just too much supply for limited demand, and there are no real tangible, massive demand drivers to soak up that incremental supply. So it is a central business district that suffers from competitors around it. West Hollywood, or sorry, West L.A. offers more attractive properties for some office users. Then you've got Century City, which has the trophy assets in the market. So downtown L.A. really almost fits more of that super regional mall traditional story of the area, the demand in the area, just cannot support three competitive assets. So you're going to have that bifurcation. One's going to win, and one to two are going to lose. So that's the story in downtown L.A., for example. If we move to San Francisco, that area,

has so many headwinds, but, you know, one of the major issues is the amount of tenant concentration. It's healthy to do a compare contrast of San Francisco and New York City. San Francisco and New York City both had full valuations. They had a lot of international investors that really supported high per square foot valuations for office real estate. San Francisco before 2019 had, before COVID, had a sub-5% vacancy. and now it's closer to, you know, 30%. It still has headwinds to remote work.

I was just reading that around, you know, I think around 30 plus percent of job postings are remote in San Francisco. Compare that to Manhattan where you're attracting talent that wants to be there, wants to live there, and there's a large financial presence that is going to demand their tenants or in the office. In the technology space, you have some larger employers, like a Google that have indicated they want some type of office presence, but you also have many smaller firms that would love to continue to save money on office expense. And their business

models work fully remote, and they're going to continue to benefit from that until, you know, their venture capital investor demands that they get an office space and go about things that way. So San Francisco, you know, unfortunately, it has way too much tenant concentration. There's a decline in office-based demand in that sector. And then adding insult to injury, the valuations were so frothy that these owner-operators are inevitably, particularly over-levered with their debt. So this idea that the catalyst of making a faster decision on what assets you keep, what assets you leave is your debt maturity, I think there's around $4 billion of San Fran office in this commercial mortgage back securities market that's coming due in 2024.

So we'll see how more of this plays out. And then unfortunately, San Francisco also has declined in its level of attractiveness for employees. There are plenty of reports. Everyone sees them of blights, crime, et cetera. So it really continues to suffer. And it doesn't take too much to try to improve things. but if we think about the tech bubble, I think that took around six years

for San Fran to come back. So it's going to take some time and concerted effort. You know, you mentioned Century City, and that happens to be where Bloomberg has its Los Angeles office, which I've visited, and it is indeed trophy property, exactly like how you, I think, imagine,

you know, the ground floor, there's like sweet greens and pokey restaurants, et cetera. You know, we've done, we did an episode once on the challenge. of converting office to a residential, which is very tricky and limited. How much effort is there, or how possible is it to upgrade a, I don't know, class B to something that resembles Class A or Class A to something that resembles trophy? Is that a thing that some of these owners of underperforming assets are attempting to do? It is a thing, but it's not super easy and it's

expensive, especially when everyone's cost of financing has shot through the roof. But it just takes, everyone should have upgraded their lobby and their elevators over the last kind of five to 10 years. And what a fantastic time to do it, you know, with respect to COVID and having no tenants in. Not everyone did that, but that's a great example of a Class B effort to maintain relevance. And then also, if you're looking at some of these smaller office spaces that are a lot of kind of class B and C, the focus is less to make them all of a sudden a trophy and more to design around what the tenant demand is. So hopefully you still have, you know, doctors, dentists, or lawyers or somebody that is comfortable with a smaller office footprint. There's a geographic

attraction. They want a lower per square foot valuation, but they're also going to need better natural light. They're also going to need likely a better floor plan. And that costs money from the sponsor. So I'd say we're likely to see the Bs and the A minuses make upgrades to make themselves more attractive to tenants and make economic decisions that way, rather than see too many assets go from an A minus B to we're going to just go for broke with trophy. There are some assets that are that we're having fun watching. I'll give you an example, but at 245 Park is in New York City. It's a large, you know, I think it's fair to call it a trophy office. It was owned by H&A back in 2017 with some very aggressive financing up to 80 percent, loan to cost. And the me me

Oh, yeah. Sorry. You just reminded me. H&A had like a really weird portfolio of properties from what I remember. Yeah. So there was a there was an influx of international buying, but particularly some of these Chinese conglomerates that had insurance, but also pharmaceutical companies and H&A and Anbang are examples. And their portfolios included things like air airlines. And then they really leaned into New York City office. And New York City office, you know, as well as some San Frane office, the benefit of those kind of investments is you're putting a slug of money to work at once, right? These are expensive. They're large. We have excellent property rights here. You do have kind of an established tenant role and can feel good about underwriting the cash flow. And at the time, financing was really

cheap. So you could buy, you could go on a buying spree with pretty attractive financing. So for this 245 park property, ultimately, S.L. Green moved from being the most subordinate lender to the owner and operator, so using their lender rights when H&A defaulted. And 245 Park, I was able to visit by leveraging the fact that I'm a client to one of their tenants. And it was really fun to see. That's a space where you're not going to compete, you're in an area with J.P. Morgan's new build and you're in an area with S.L. Greens 1 Banderbilt, you're not going to suddenly become them. But what you can do is upgrade what you have and benefit from your excellent location right by Grand Central. So I got to see their executive floor. So you lean into things like that. Your

tenants want a really fancy floor to bring their clients in. The entryway was great. Everything had everything that I saw had more of a luxury feeling. So I think that's probably a great example of an older asset that's making strategic upgrades to really hold its own, even though it can't suddenly become a 2020 delivered, you know, new build. So setting upgrades aside, can you talk a little bit more about the options that sponsors actually have? So let's say I'm sitting on a property that no longer makes economic sense. Like what are the options that I have? I guess they span like a range from trying to raise additional capital to maybe just handing back the keys or something like that. Yeah, and that's key,

you know, part of our investment analysis on the dead side. So it is very easy in the commercial mortgage-backed securities market to just hand back your keys. CMBS isn't a relationship lender like banks or insurance companies. So, and what do I mean by relationship lender that there's no recourse in a CMBS loan? It just asks for adverse selection for response. And you see that translate into their financing. So sponsors at the end of the day, they're obligated to pay their debt on an asset. If they don't, they're in default and lender rights kick in. They can either negotiate with the lender to get a modification.

A modification can include some type of relief for a temporary period of time. Forbearance is what it's called on their cost of financing, sorry, on their loan. Or it can include more structured solutions like, an extension for two to three years at some sort of adjusted rate within a lower rate, with an incremental kind of equity investment, good faith investment from the sponsor. And we're seeing that play out. If you took out a fixed rate loan five years ago, you're incentivized to extend that fixed rate maturity rather than go into today's market and accept lower valuations on your

asset, lower leverage on your asset, higher cost of financing, and come out of pocket. So we'll continue to see those maturity defaults and modification extension solutions. And that's actually encouraging to see in a number of circumstances because it at least signals that the sponsor cares about this asset. You know, we're always going to look for evidence of them continuing to invest in the asset and ensure it's relevant and generating income and whatnot. but the fact that they're not immediately walking away is encouraging. Whereas on the other side, give you some examples of tenants walking away, or sorry,

of sponsors walking away. We talked about 1740 Broadway for Blackstone in New York City. You also have gas company tower as an example in downtown LA and the EY building where Brookfield walked away. And that is, it is as simple as no longer paying your debt and basically not answering the call. when servicers are looking to find you and not being available for a solution. Are there? Are there repercussions for doing that?

Like, you know, does Brookfield's reputation take a knock when it just walks away from a property like that? Or is it just business? Unfortunately, there aren't enough repercussions. That's kind of part of the fun with CNBS, I suppose. We do focus on sponsors and their capitalization. So it's a great example of Brookfield is well capitalizing. But you have to also check on the assets performance and the assets relevance in their portfolio to really determine if this is going to be something they focus on and they keep. And I mentioned earlier that CMBS in particular is a non-recourse lender and it's not really a relationship lender.

So it lends itself to adverse selection. And you saw that, you know, both on the retail side as well as in today's office market to give you examples. Simon Property Group, an excellent owner-operator of malls, would strategically finance their non-core malls in CNPS. They would get pretty creative. You could see there was zero incremental investment in the assets, but somehow, you know, the valuation has increased off of, you know, no incremental cash flow growth, really just a capital market's arbitrage benefiting from lower rates, lower cap rates. You'd also see them take three properties and combine them with one that's pretty good and then two that are weaker and juice the overall metrics to see if the debt investors

would feel more comfortable with owning that security. On the office side, you also see some strategic adverse financing. I use the example of gas company tower for Brookfield. And there, they use shorter floating rate debt. And that's where it's tough to underwrite the asset for 10 years. You really can't afford to support a 10-year fixed rate because your tenant role is heavy. Your current occupancy is weak. And then they levered it with additional debt beneath the mortgage, so mezzanine debt. And so really, that can be viewed, not to be too cynical, but debt investors, we have to be cynical, as trying to reduce your basis in the asset as much as possible and set yourself up to even more conveniently walk away.

And that's exactly what happened. You just hold the asset while you're still collecting cash flow from it. As soon as rates reset and you have to come out of pocket to cover cash flow, you're walking. Yeah, as simple as that. I have just two questions. And then one is very short. The next time you're in New York for work, can you take me and Tracy on a like an office field trip? Just bring us along.

Okay, great. We'll make that happen. So I guess the other question, going back to the malls, like as you've mentioned, I remember, you know, the zombie mall discourse, the end of the mall. And as you pointed out, it was just way too simplistic because not all malls were the same. What happened to those zombies, the ones that really were dead? Did they become top golf locations? Did they get totally torn down?

Is there any lessons to be learned about what ultimately happened to physical spaces that, like, just were nowhere close to being economical in the new era? Yeah, it's still playing out. So you are seeing a transfer of ownership. We talked earlier about the Simon example. Simon has excellent malls, class A malls now, or you can find Class A plus malls that are over 1,000 per square foot sales versus 600 years ago that seemed more attractive, 650. So they exited non-core assets in their portfolio.

There are some owner operators where that's their niche. They're going to find the unloved mall that has been held by a really, big player and there's been no leasing activity or focus on tenant composition for the last 10 years and try to rehabilitate it. And there's probably some, you know, reduction overall of square footage. And then there's also that kind of upgrade into whatever the demand looks like for the local population. Top golf, you mentioned Joe. That's fantastic. I love top golf. So that's a great example. You know, that there should be more top golfs everywhere. Yeah, but you see Bowling Avenue, David Buss That is actively happening and continues to.

And then there's some where it's just going to be an empty parking lot and a dilapidated building that's just going to be, you know, blight effectively for years. There was, frankly, overbuilding. There are areas where you really don't need it. There are some efforts to redevelop into multifamily, for example. And that takes time and good developers and owner operators and coordination with, you know, local, governments. And you'll probably remember when there was so much buzz about all these spaces becoming industrial facilities. And that's maybe a great example to talk about bifurcation as well. In theory, if you have a mall that's typically located at a highway intersection, it could be a good location

for some type of warehouse distribution. But in practice, new builds is relatively efficient and is what tenants like an Amazon typically want. And you can also find cheaper to access or easier to own and operate space away from just absorbing a two million square foot, you know, structure. So it was kind of theory versus practice. That is also, you know, we're not going to save all malls through industrial the same way. We're not going to save all office properties through multifamily conversion. So I am conscious of the time and I realize we could probably, Hours. Yeah, we could go on for hours with you. But just listing addresses. Talking about individual properties. But since we are on the theme of bifurcation, I feel like I have to ask you about differences in the capital stack as well. So like junior versus senior loans for commercial properties, are we seeing that bifurcation story there as well?

We are. Yeah. You guys are aware. There's plenty of stress in the CRE market. But under the hood, there's all. also risk transfer in, you know, subordinate notes. So mezzanine, for example, you've got some players that are going to take advantage of that as an access point to take over assets. You've got other players that bought a 5% fixed rate mez thinking it was an attractive return three years ago in a relatively safe asset that no longer want to have that exposure. It's defaulted. They don't know what to do. They weren't trying to access a property through that. So from our perspective, we have as debt investors where we're trying to make thoughtful investments where we're not having to take over an asset, that would mean that it defaulted. There's some examples where,

you know, maybe that's a play we could consider. So we're typically reviewing or we're always reviewing the quality of the asset. Most investors are going to focus on things that avoid default. And then where you play in the capital structure is going to be determined by, you know, relative value and kind of sourcing. So we were more commonly in, the mortgage portion, the CNBS portion that gets kind of tranched out. So you can play in seniors, you can play across the cap stack. As you'd expect, if you like the mortgage, so let's say it's a $1 billion mortgage, you typically like the billion dollar CNBS deal that's terming out that mortgage, that's re-framing it into more marketable securities. And then your decision-making

really comes down to relative value. With respect to reviewing the capital structure, you always want to be mindful of how much leverage is on the asset. And the reason the sponsor took out so much leverage, it typically is a negative signal. If there's too much complexity in the capital structure, if you've got three Mez notes, that's an easy red flag. That means you couldn't find one slug of mez. You couldn't find a buyer for one slug of mez. Instead, you're kind of just trying to slice a dice and find the best buyer for specific portions and their levels where they, you know, the return they need to see to take that risk. And then also, you always want to see who those buyers are because they are first in line to navigate distress in the asset. We talked earlier about

245 Park. When we see HNA as a non-traditional owner operator of New York City office, acquire that asset at an uneconomic capitalization rate, that's a head scratcher and 80% blown to cost is a head scratcher, but when you see SL Green position themselves in that MESC, you know how that's going to work out. You know they are strategically investing in that most subordinate MES to be in position to step in and ultimately take control of that asset. So those are all things. We're always analyzing who the players are looking at relative value across the capital structure. And then for our, you know, most of our client portfolios really focused on the debt side. And I don't want to surprise.

you all, but plenty of people that are focused on the debt side that underwrite to find credits that that should avoid defaults are probably scratching their heads at the amount of loans that have default risk in their portfolios. And I think that fits into some of the regional banks. And we'll see that kind of play out over time as well. Oh, man. I feel bad ending the interview right there because I would love to talk about bank exposure to CRE, although I think we did do an episode earlier in the year. Okay, so we are sort of covered, but our producers are giving us the time sick. But Liza, that was so good. Thank you so much for joining Odd Lots.

Really appreciate it. This was so much fun. I appreciate y'all letting me join and I'm completely happy to take y'all on property tour. Great. We are serious. We are for real going to take you up on that next time. Or next time we're in L.A. We should also happen.

We will do it. Excellent. Sounds great. Joe, just to bring it full circle. Yeah. One of the loans financing Highland did actually. did actually end up in a CMBS deal. It was put together by J.P. Morgan. And I think that the only reason I remember it is because I wrote about it back in 2013. The reason I wrote about it was because that

particular CMBS deal had a reported loss of 120 percent, which was the highest ever recorded for a CMBS deal at the time according to Moody's. I'm not even sure how you can get a loss above 100 percent, But yeah, I just, that's crazy. Yeah, I'd have to go back and look at it. But yeah, crazy stats. So there was so much to pull out of that conversation. One thing that kind of surprised me, but it makes intuitive sense is this idea that, you know, if you have a property, you kind of have to keep putting money into it. And like, Liza was talking about how with regional malls, if you're walking around and you see seasonal decorations, like Christmas decorations, that's a good sign.

it means someone cares about the property. So I guess B-class office building should be putting up decorations. At least put up a wreath in the lobby. By the way, I said that our office here didn't have any Instagram walls, and then our producer Dash immediately messaged me. And he said, we do have a very grammable office. I have graham from here, fish tanks, the curved escalator. So we do have plenty of visual delights in our office.

But to the conversation, I thought that was amazing. And obviously, I really liked the dig. I mean, I loved that Liza was able to mention so many specific addresses. And I could hear, once again, both of us typing at the same time, looking up those addresses. 1740 Broadway, the Mone Building. I didn't written. It's an interesting Wikipedia page. And then also I liked some of the things, especially at the end, the clues you can get from looking at who's who in the capital stack in response to your question.

Just like, okay, you have this sort of untraditional main sponsor, then this sort of savvy player at the Mesley. level. They might be positioning themselves to take it over at some point. That is, I really enjoyed the way she was able to bridge both like this sort of the highly technical financial stuff as well as just, you know, the building of good light. Yeah, exactly. Yeah, we'll have to have have Liza on again next year and talk some more because there are so many more questions that I want to ask her. But for now, shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me at Tracy Allaway. And I'm Joe Wisenthall. Follow me at the stalwart.

Follow our producers, Carmen Rodriguez at Carmen Armin, Dashel Bennett at Dashpot, and Kel Brooks at Kel Brooks. Thank you to our producer, Moses Ondom. For more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have transcripts, a blog, and a newsletter. And if you want to talk about dead malls or trophy office buildings or anything else, real estate, go to our Discord. Discord.g.g. slash odd lots.

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