Imagine getting a piece of the profits from luxury skyscrapers on “Billionaire’s Row.”
That’s 57th Street, on the southern end of Central Park in New York City, and it’s home to some of the most expensive real estate on the planet.
Apartments in the skyscrapers jutting from that sliver of land have sold for as much as $250 million.
They are trophy assets that only the ultra-wealthy can afford.
It sounds like an investor’s dream… but the unfortunate investors financing the construction of one of these towers learned the hard way that the shiniest things may not be the best for your wallet.
Here at the Intelligent Income Daily, we’re focused on finding the safest income investments on the market. Many new investors are drawn to stocks that offer high yields, but don’t understand the risks that come with investing in these companies.
Today, I want to tell you a cautionary tale about Apollo Commercial Real Estate Finance (ARI), the real estate investment trust (REIT) that financed (and fumbled) the construction of the Steinway Tower at 111 West 57th Street. It’ll show you why chasing yield isn’t always such a good idea.
Sky-High Yields Can Mean Sky-High Risk
The Steinway building is an 82-story supertall residential tower with roughly 400,000 square feet and 60 condominiums. The tower holds the title of the world’s most slender skyscraper, with a width-to-height ratio of approximately 1:24.
Plans for the skyscraper, initially to be built next to Steinway Hall, date back to as early as 2005. The project was passed along to several different investor groups, eventually ending up with a company called JDS Development Group. JDS also purchased Steinway Hall and included it in their plans for the skyscraper.
Construction began in 2014. But costs quickly spiraled above budget due to complications with Steinway Hall’s status as a landmark.
The developers needed more money.
Apollo made its first investment in the Steinway Tower in 2015, offering a $325 million mezzanine loan.
A mezzanine loan is a form of junior, subordinated debt. That means that it’s last in line to get paid back, and the first to take losses if a borrower defaults.
Simply put, it is much higher risk. But the higher risk comes with higher yields. And those lucrative returns were exactly what Apollo was chasing after.
Just two years later, the developers defaulted on Apollo’s loan. To rescue their investment, Apollo sold off $25 million of its loan and agreed to put the remaining $300 million into forbearance. That meant that they wouldn’t even get interest payments on the debt.
Meanwhile, construction of the tower had stalled due to lack of funding and lawsuits among the various investors involved.
The tower finally reached its planned height in 2019. But then the pandemic hit and construction slowed again. It wasn’t until late last year that the skyscraper was finally completed.
By that time, Apollo had dumped over $840 million into the project through a series of debt refinancings and new loans.
Now that the tower is finally finished, Apollo’s nightmare may finally be over right? Not so fast.
Avoid the “Pipedream” Picks
Even though a few condos in the building have been sold, Apollo still holds nearly $750 million in loans connected to the project. And they’ve started writing them off: in the latest quarter, they logged a $36.5 million increase in loan loss reserves because units are going for lower prices and taking longer to sell than they originally assumed.
When I spoke with an insider at the company, they told me that this high-risk loan is highly speculative and that investors have been paying the price for this pipedream.
Despite the 10%+ yield, investors would have suffered through multiple dividend cuts and a falling share price to net just 3% in annualized total return over the past 5 years – and that’s if they reinvested all of their dividends.
The moral of the story is that stocks with very high yields are often that way for good reason due to the risks involved. When it comes to chasing a sky-high yield, remember that you need to do your homework on the fundamentals that hold it up.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily
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Source: Wide Moat Research