Investors and Stuy Town

The irony of Cassandra’s invocation may have escaped the dissenting justice. While the real estate industry’s attention is now fixated on the potential for a default at Stuyvesant Town, this very outcome was suggested when the sale of the property was first announced in 2006. But the market observers who derided the deal at the market’s apogee were Cassandras in their own right. Today, they would suggest that the apparent collapse of Tishman Speyer and BlackRock’s $5.4 billion investment was easily foreseen and is altogether independent of the economy’s having fallen into recession.

The property cash flow in late 2006 was well below the debt service on the sum of the related $4.4 billion mortgage obligations. The loans were made under the premises that the property was purchased for more than $480,000 per unit. In particular, it was assumed that cash flow would grow at a brisk pace as apartments were renovated or otherwise escaped rent stabilization. In the interim, an interest reserve of $400 million was set up to cover shortfalls in debt service coverage. Like the interest reserve, additional upfront reserves of $250 million-principally $190 million in a general reserve and $60 million in a capital expenditure reserve-are now almost totally depleted.

In a defining bathos of the recent developments, a rating agency reported on Friday that is was reviewing certain bonds related to the Stuyvesant Town loans. In an early 2007 presale report for the CMBS, that same rating agency used its estimate of calendar year 2011 cash flow to calculate its “actual” measure of Stuyvesant Town’s debt service coverage. Employing a more pedestrian definition of “actual,” the Stuyvesant Town’s debt service coverage in late 2006 was approximately 0.4.

Apart from the specifics of last week’s decision, a default of the magnitude and visibility of the Stuyvesant Town loans bears implications for a broader class of investors’ perceptions of risk in holding CMBS exposure.

As a result, it may exert a chilling effect on current efforts to reignite securitization activity and liquidity in secondary CMBS markets. The fifth round of the term asset-backed securities loan facility (TALF) in support of CMBS was held by the New York Fed just last Wednesday, to no avail for new CMBS issuance.

Confounding efforts to rebuild confidence in securitization, many investors will view a prospective default at Stuyvesant Town as a result of systemic issues in the CMBS market that have yet to be properly addressed, and not just as an asset-specific issue.

Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.

Investors and Stuy Town