The refinancing of landmark building The Squaire at Frankfurt Airport provides a useful indicator of how commercial properties are being valued in the absence of much alternative price visibility. It's worth looking at the deal more closely to see how the big number crunchers are currently approaching valuation of core office properties.
The property will be well known to anybody who in the days of business travel would fly in and out of Frankfurt Airport. It's not high, but it's very long, running the whole length of the airport's train station, and hence became known as a 'groundscraper'. It was developed by IVG Immobilien between 2006-11, and its legendary cost overruns helped contributed to ultimately driving IVG into insolvency.
Blackstone's OfficeFirst German subsidiary took over the property, and subsequently sold it in December 2019 to a consortium of international investors led by London-based AGC Equity Partner, which included South Korea's Hana Financial.
Now Bank of America Merrill Lynch has launched a €473 million securitisation of a €548m senior loan it granted last year against the 145,000 sqm property. The six-tranche Taurus 2021-3 DEU CMBS has an expected maturity date of December 2024 and a six-year tail period to 2030 final maturity. Taurus 2021-3 DEU is the third CMBS to finance the Squaire since its completion in 2011.
In accordance with risk retention regulations, the bank will retain at least 5% of the €548m senior loan, which represents a 65.8% loan-to-value based on a valuation of €832.6m.
This would value the property at 11% lower than the last price paid on the AGC transaction, which was thought to have been about €930m. (At the time, REFIRE reported Korean business paper putting the price at 1.3 trillion Korean won, which would have been closer to €1bn at then exchange rates.)
On March 17th, ratings agency Fitch in London issued a note on the CMBS based on publicly available information (they were not asked to rate the securitisation), suggesting that the 10% increase on the senior debt secured on The Squaire heightens credit risks triggered by COVID's overall impact on air travel.
Current occupancy is 96%, but The Squaire also includes two Hilton hotels where, according to rating agency Moody’s, the rent fell last year from €21.6m to €4.6m due to the trading problems caused by Covid-19.
Fitch said in its note that it viewed the transaction's increased leverage coupled with the property's vulnerability to post-pandemic business travel risks as "inconsistent with our highest investment-grade ratings".
It argued that, given that The Squaire's office space primarily serves professional services firms attracted by its unique access to the airport terminals, while air travel will pick up as the global vaccine rollout continues, it will be inconsistent.
"We identify a material risk of a sustained, meaningful reduction in business travel in the wake of the pandemic given how seamlessly virtual meetings have replaced face-to-face meetings, and their significantly smaller carbon footprint in an increasingly ESG-focussed world", said Fitch.
It added: "We believe the collateral as a whole is highly vulnerable to market value decline in the absence of a strong rebound in international business travel. The rebound's high uncertainty both in scale and timing means it warrants more severe downside scenarios than in 2018, especially in higher rating categories. (This is a reference to a previous now-repaid CMBS secured on the asset, Taurus 2018-3 DEU).
"However, 'AAAsf' equivalent debt per square metre (adjusting for pari passu debt) has grown faster than collateral value - 17% versus 12% - since the issuance of Taurus 2018-3 DEU, and more in line with the 19% increase in reported office value through to September 2020. In our view KPMG's decision to extend its lease in the office from 2019 to 2028, and take 6,000 sqm more space, is a key driver of the increased debt as it accounts for around a third of gross collateral income."
Rival agency Moody’s said that the office space, let principally to KPMG and Lufthansa, has generated enough cashflow to service the loan. Lufthansa’s lease is due to expire next year. However, as part of the airline's overall shrinkage plans, REFIRE understands that Lufthansa staff have already vacated the building a year ahead of the lease break. This accounts for about 10% of income from the property.
The loss of the Lufthansa staff will obviously negatively affect ancillary businesses such as bars and restaurants in the The Squaire's extensive concourse. According to Bloomberg, the severe restrictions on air passenger numbers since the start of the pandemic have also caused a steep decline in income from the two hotels housed within the complex, with gross operating profit down around 75% since 2018.
Also, despite the exceptional location of The Squaire with its first-class road, rail and airport links, Fitch points out that KPMG's extended commitment to more space was renewed before the onset of the COVID pandemic. It says, "If The Squaire's unique proposition has become less competitive, relegating it from regional hub to local office, it will face a growing threat from remote working.
"The pandemic's legacy, beyond its manifest impact on The Squaire's hotels, could seriously weaken re-letting prospects in its offices. Lower-for-longer interest rate expectations, already responsible for German office yields tracking all-time lows, increase the risk of a severe correction in collateral value through the next phase of the pandemic."
