Tempus’ Progress During Turbulent Times

Banking Environment:

Throughout 2023, stories of troubled banks have filled the headlines of the Wall Street Journal, Forbes, Bloomberg and just about any other financial news outlet. The first series of bank failures included Silicon Valley Bank on 3/10, Signature Bank on 3/12 and Credit Suisse on 3/19. These bring back memories of the 2008 financial crisis where banks were plagued with credit problems from subprime mortgage bonds. In 2023, banks are facing a much different problem, a liquidity crunch. According to the FDIC, bank deposits grew 38% from December 2019 to December 2021, mainly due to the COVID stimulus. During that period, banks saw an increase in their loan portfolios of only 7%. As a result, banks increased their holdings of US government securities by 53% when rates were near historic lows. Since December 2021, the Fed has tried to tame inflation by increasing the Fed Funds target rate at unprecedented speed — up from 0.25% in March 2022 to 5.00% in December 2023. This dramatic rate increase has negatively affected the value of the US government securities those banks purchased.

Current banking regulations require banks to hold US government securities into two buckets “available for sale” and “held to maturity.” When labeled “available for sale”, banks mark-to-market the now reduced value of their holdings each quarter; however, if marked “held to maturity”, they are not required to mark-to-market since they are not planning to sell the security. Once the first wave of banks failed in early March, depositors became concerned with their ability to access deposits. This resulted in deposits flowing from smaller to larger banks, many of which are deemed too big to fail.

According to the Fed, banks outside the 25 largest have seen approximately $300 billion reduction in deposits during the first quarter of 2023. Depending on each bank’s liquidity, when there is a run on deposits, the bank is forced to sell securities to meet demand, and this can include those in the “held to maturity” bucket. Once the bank sells a single security in this bucket, they must mark the entire bucket to the market value. This mark-to-market can wipe out a significant amount of the bank’s capital and, in some instances, force the bank to sell or be taken over by the regulators.

Commercial Real Estate Market:

In addition to banking headlines, the struggles of commercial real estate have been a consistent narrative. We have seen the US Office Vacancy rate reach a recent high of 12.9% and record amounts of sublease space are available. The front page of the Wall Street Journal recently included articles on Veritas defaulting on a $450 million loan, another lender receiving 3,200 apartment units back in Houston, and office real estate giant Brookfield faced with delisting from the NYSE.

We are constantly paying attention to all of these, and if one digs past the headlines, each article is filled with a few common attributes. These articles include properties in the gateway markets that remote work has hit the hardest, like San Francisco, New York City, Los Angeles, Houston, Miami, Seattle and Chicago. For a couple of reasons, owners in these markets face a vastly more challenging landscape than those in the markets where Tempus focuses. First, a unit of space in these gateway markets historically sold for 5-15 times the value of comparable space in the Midwest and Southeast. This price difference was almost solely attributable to the location value of the property as opposed to the new construction cost. Historically, users were willing to pay far more for space in downtown New York City or San Francisco than for the same space in Columbus or Indianapolis, but Covid has caused employers to examine the utility and location of office space in general. Users found themselves asking, “How much utility is achieved by having a large office in expensive major markets?”. Additionally, “Could similar utility be achieved with some or all that space in secondary markets where rent is cheaper, and employees are returning to work much faster?”.

These pressures and lofty valuations create an incredibly difficult environment for landlords in gateway markets. These landlords purchased properties with a much lower income yield, so to increase returns, maximum leverage at floating rates or short-term maturities was used. This strategy results in a risk profile leaving a small margin for error. The combination of higher interest costs and lower rental rates has presented an impossible combination for some owners.

In contrast with this strategy, Tempus has consistently kept our leverage at 65% or below, fixed rates and loan terms between 5-10 years. Across our properties, we have approximately $415 million in outstanding debt at an average interest rate of 4.10% and a remaining term of 4.6 years. This strategy has a muting effect on our returns in booming markets but is invaluable in times like this.

Progress During Turbulent Times:

Overall, our experience has been remarkably different from those of our peers in major markets. Despite the rising interest rate environment and post-Covid reassessment of office needs, our portfolio is strong and improving. We are aggressively managing our properties to ensure they are positioned as best as possible. As part of this strategy, we have added (or are adding) amenities to our properties in Columbus, Minneapolis and Indianapolis. The "spec suite program" has been successful at our Dallas assets, and we have taken this strategy to other markets. Additionally, we have seen an increase in leasing activity across our portfolio. Since 2020 large tenants (10,000+ SF) have been largely stagnant, but over the last quarter, we have seen an uptick in activity among these larger tenants. Across our office portfolio, we are currently working on prospects that, in the aggregate, would occupy over 40% of all the vacancies in our office portfolio. Though many of these prospects are in the early stages, we see many property owners tight on capital, so we will maintain a strong position allowing us to pursue these tenants aggressively.

Evergreen Update:

Over the past quarter, we have received questions regarding our long-term view of Evergreen since we launched it in the 2nd quarter of 2022. As mentioned above, immediately after Evergreen’s launch, the Fed began rapidly raising rates, thus having a negative impact on the broad office and industrial market. Evergreen has remained resilient with its top-tier assets and long-term fixed debt. Last week, we received a valuation as of April 30th from Ernst and Young on the properties and debt of Evergreen.

This valuation shows an increase in NAV per share, with the values of the properties down 3.95% year-over-year but more than offset by the value of the fixed rate debt the fund secured. Evergreen has over $85M in outstanding debt at an average interest rate of 3.76% and an average duration of 7.59 years. When comparing the rate and maturity to today's lending market, Ernst and Young concluded that this facility adds $8.6M in value to the fund. This results in a NAV increase of approximately 4% over the first 9 months in addition to 3.75% in cash distributions for a total return of 7.75%. For comparison, public REITS reported -2.68% for the same period and -8.80% for the private REIT index. Tempus Evergreen is performing exactly as it was designed to do, even in this challenging market environment.

Clay Ramey
Partner — VP Capital Markets