Real Estate Leverage Datapoint of the Day

If you lend so much money to Hilton hotels that you know its

cashflows can’t cover the coupon payments, at least you have the reassurance

that Steve Schwarzman is looking to get huge returns on his

equity, and that he can’t do that without staying current on his debt. What

on earth are the lenders

to buyers of office buildings thinking?

Some loans used so-called negative leverage — when a buyer’s debt payment

is more than the income the property produces. In the past, banks underwrote

loans based on current cash flow — typically the rents landlords receive

from tenants. As the market heated up and banks competed against each other

to produce loans, some began underwriting loans based on expected future income


Some of these riskier loans, especially in the white-hot Manhattan

office market had been based on the current pace of rent increases-about 25%

in the past 12 months in Manhattan — continuing for 10 years or more.

I don’t get this at all. What are the chance of Manhattan rents, which are

alraedy at an all-time high, rising another 25% a year for 10 years? That’s

a total increase of 931% – so if rents are say $75 a foot today, they’re

expected to be $700 per square foot in 2017. Which is ridiculous on its face.

Even if inflation comes in at 3% a year over that time, we’re still talking

rents of $550 per square foot in real terms, which is a level five times higher

than the very top of today’s market.

In fact, this number is so hard to credit that I’m sure there’s some kind of

mistake here. Lenders might have been crazy, but they weren’t that


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