Tag Archives: commercial real estate

Interest-Only Issuance Has Skyrocketed, But Is lt Time To Worry Yet?

A larger volume of CMBS loans are being issued with interest-only (IO) structures, but this rise may put the CMBS market in a dicey position when the economy reaches its next downturn. To put things in perspective, interest-only loan issuance reached $19.5 billion in Q3 2018, six times greater than fully amortizing loan issuance. In comparison, nearly 80% of all CMBS issued in the FY 2006 and FY 2007 was either interest-only or partially interest-only loans.

In theory, the popularity of interest-only loans makes sense, because they provide lower debt service payments and free up cash flow for borrowers. But these benefits are partially offset by some additional risks in the interest-only structure, with the borrower’s inability to deleverage during the loan’s life perhaps being the biggest concern. Additionally, borrowers who opt for a partial interest-only structure incur a built-in “payment shock” when the payments switch from interest-only to principal and interest.

Why are we seeing a spike in interest-only issuance if the loans are inherently riskier than fully amortizing loans? Commercial real estate values are at all-time highs; interest rates are still historically low; expectations for future economic and rent growth are fundamentally sound, and competition for loans on stabilized, income-producing properties is higher than ever. Furthermore, the refinancing pipeline is miniscule compared to the 2015-2017Wall of Maturities, so more capital is chasing fewer deals. This causes lenders to augment loan proceeds and loosen underwriting parameters, including offering more interest-only deals.

Then and Now: Why the Rise in 10 Debt Has Raised Concerns

Between Q1 2010 and Q1 2012, fully amortizing loans dominated new issuance, with its market share amass­ing as much as 80.4% (Q1 2012). Interest-only issuance was nearly equal to the fully amortizing tally by Q3 2012, as interest-only debt totaled $5.10 billion, only $510 million less than fully amortized loans. Interest-only issuance would soon overtake fully amortizing loan issuance by Q2 2017, as its volume skyrocketed from $5.3 billion in Q1 2017 to $19.5 billion in Q3 2018.

Prior to the 2008 recession, the CMBS market experienced a similar upward trend in interest-only issuance. By 02 2006, interest-only loans represented 57.6% of new issuance, out­pacing fully amortizing notes by 38.86%. The difference in issuance between interest-only and fully amortizing loans continued to widen as the market approached the recession, eventually reaching a point where interest-only debt repre­sented 78.8% of new issuance in 01 2007. Even though the prevalence of interest-only debt is mounting, why would this be a concern in today’s market?

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IO Loans Are More Likely to Become Delinquent

Interest-only loans have historically been more suscep­tible to delinquency when the economy falters. Immedi­ately following the recession, delinquency rates across all CMBS loans moved upward. Once the economy began to show signs of recovery, the delinquency rate for fully am­ortized loans began to decline, while interest-only and par­tially interest-only delinquencies continued to rise. In July 2012, the delinquency rate for fully amortizing loans was sitting at 5.07% while the interest-only reading reached 14.15%. The outsized delinquency rate for interest-only loans during this time period is not surprising, since many of the five-year and seven-year loans originated in the years prior to the recession were maturing. Many of the borrowers were unable to meet their payments due to significant declines in property prices paired with loan bal­ances that had never amortized.

Over time, the stabilization of the CMBS market led to subsequent declines in the delinquency rates for both the interest-only and partial interest-only sectors. The delin­quency rate for interest-only loans clocked in at 3.17% in December 2018, which is down nearly 11 % from its peak. Delinquency rates across all amortization types have failed to return to pre-crisis levels.

Just because a large chunk of interest-only debt became delinquent during the previous recession does not mean the same is destined to happen in the next downturn.

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Measuring the likelihood of a loan turning delinquent is typically done by calculating its debt-service coverage ra­tio (DSCR). Between 2010 and 2015, the average DSCR across all interest-only loans was a relatively high 1.94x. Since 2016, the average DSCR for interest-only debt has fallen slightly. If the average DSCR for interest-only loans continues to decline, the inherent risk those loans pose to the CMBS market will become more concerning.

The average DSCR for newly issued interest-only loans in March 2019 registered at 1.61 x, which is about 0.35x higher than the minimum DSCR recommended by the Commercial Real Estate Finance Council (CREFC). In 2015, CREFC released a study analyzing the impact of prudential and securities regulation across the CRE finance sector. In the study, CREFC cited a 1.25x-DSCR as the cutoff point between relatively healthy and unhealthy loans. The value was chosen through loan-level analysis and anecdotal information from conversations with members.

The figure below maps the DSCR for both fully amortizing and interest-only loans issued between 2004 and 2008. Notice that toward the end of 2006, the average DSCR hugged the 1.25x cutoff level recommended by CREFC. Beyond 2006, the average DSCR for interest-only loans oscillated between healthy and concerning levels.

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The second figure focuses on CMBS 2.0 loans, where a sim­ilar trend can be spotted. After roughly converting interes-t­only loan DSCRs to amortizing DSCRs using underwritten NOI levels and assuming 30-year amortization, the average DSCR for interest-only loans issued between 2010 and mid- 2014 (2.04x) is much greater than that for fully amortizing issuance (1.78x). While part of this trend can be attributed to looser underwriting standards and/or growing competition, the other driver of the trend is due to selection bias. Lend­ers will typically give interest-only loans to stronger proper­ties and require amortization from weaker properties, so it makes sense that they would also require less P&I cover­age for those interest-only loans on lower-risk properties.

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What Lies Ahead for the IO Sector?

Rising interest-only loan issuance paired with a drop in av­erage DSCR may spell for a messy future for the CMBS industry if the US economy encounters another reces­sion. At this point, CMBS market participants can breath a little easier since interest-only performance has remained above the market standard. However, this trend is worth monitoring as the larger volume could portend a loosening in underwriting standards.

Source: by Trepp | ZeroHedge

Chinese Firms Become Net Sellers Of U.S. Commercial Real Estate, “First Time Since 2008”

Beijing is reportedly urging Chinese real-estate investors to divest their U.S. commercial real estate holdings, a cunning strategy reflecting China’s efforts to deleverage debt and stabilize the yuan ahead of future market shocks created by President Trump’s trade war.

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Taiwan News quoted Liberty Times, a newspaper published in Taiwan, suggested that a significant liquidation of U.S. commercial real estate by Chinese companies could be in the near term, as the catalyst for such an event would be explained by policymakers cracking down on bad debt.

According to the Wall Street Journal, Real Capital Analytics has noted that Chinese real-estate investors have already started dumping U.S. commercial real estate for the first time in a decade. Chinese companies have sold more real estate assets in a single quarter (US$1.29 billion) than they have purchased (US$126.2 million).

“This marked the first time that these investors were net sellers for a quarter since 2008. The more than $1 billion in net sales reflects how much the Chinese government’s attitude toward investing overseas has changed in recent months,” said WSJ.

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Chinese investors began acquiring US commercial real estate a few years after the 2008 financial crisis. More recently, Beijing officials loosened restrictions on foreign investment, which spurred investments in numerous US cities like Los Angeles, San Francisco, and Chicago with high-profile acquisitions—including the $1.95 billion acquisition of the Waldorf Astoria, the highest price ever paid for a U.S. hotel.

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The Waldorf Astoria hotel in New York, which was purchased by China’s Anbang Insurance Group in 2014. (Source: Kathy Willens/AP/WSJ) 

The Waldorf Astoria hotel in New York, which was purchased by China’s Anbang Insurance Group in 2014. (Source: Kathy Willens/AP/WSJ) 

Chinese companies like HNA Group and Greenland Holding Group have been offloading assets and potentially could create headwinds for real estate markets. The Wall Street Journal suggests that Beijing is currently pressuring companies to decrease their debt levels to lower the default risk ahead of the next credit crunch.

“I was shocked,” said Jim Costello, senior vice president at Real Capital Analytics. “They [Chinese real estate firms] really curtailed their buying and stepped up sales.”

Analysts told WSJ that increasing tensions over trade and national security between Washington and Beijing could have triggered the pullback.

“The China-US outbound cross-border real estate climate has been negatively impacted by the geopolitical climate,” said David Blumenfeld, a Hong Kong-based partner at Paul Hastings LLP.

WSJ notes that Anbang Insurance Group is considering shrinking its U.S. hotels book, but has yet to settle on any deals.

“The company is still in the process of reviewing overseas assets,” said Shen Gang, an Anbang spokesman. “We currently do not have specific asset optimization plan, nor a specific timetable.”

In June, the Green Street Commercial Property Price Index was unchanged. The index, which measures values across five major property sectors, has stalled over the past eighteen months and could come under pressure as Chinese investors have turned to net sellers.

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For many Chinese firms, the long-term investment plan in the US has been abandoned after Beijing has pressured companies to reduce their debt levels amid the escalating geopolitical tensions and trade war.

However, not every Chinese investor is pressured to liquidated US real estate holdings. Lawyers for these developers told WSJ that investors of smaller residential projects, including warehouses and senior living centers, are holding tight.

Chinese investors said the government has allowed firms to dispose of properties that have increased in value to avoid taking a loss.

Earlier this year, HNA group and a partner sold 1180 Sixth Avenue in Manhattan to Northwood Investors for around $305 million. The conglomerate, which is headquarters in Haikou, a city in southern China’s Hainan province, bought a 90 percent stake in the office tower for $259 million in 2011.

HNA Group also sold a stake in 245 Park Avenue to SL Green Realty Corp. HNA bought the tower for $2.2 billion last year.

“HNA Group has long said it will be disciplined and thoughtful about its asset dispositions as it realigns its strategy,” said an HNA spokesman. Late last year, HNA Group outlined a plan to sell $6 billion worth of properties, according to an insider.

Last month, Taiwan News said a document intended for financial think tanks in China was leaked to the press that said China was “very likely to see financial panic” and the government should prepare financial institutions, industries, and also be ready for possible social unrest. Critics suggest that China’s financial difficulties have been in development for some time, however, the U.S.-China trade war exacerbated the problem and had brought the coming credit crisis forward.

Could the US commercial real estate market be the next indirect victim of President Trump’s trade war?

Source: ZeroHedge

Retail Rents Plunge 20% Across Manhattan

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As we anticipated earlier this year, the first the signs of the coming implosion of the US real-estate bubble are emerging in the high end of the nation’s most overcrowded and expensive housing markets (Manhattan and San Francisco are two salient examples). 

And in the latest confirmation of this trend, the Wall Street Journal published a report this week highlighting how the business environment for commercial landlords in New York City’s most densely populated borough is growing increasingly dire, as landlords who had left storefronts vacant in the hope of courting the next Bank of America or CVS have inadvertently turned trendy downtown Manhattan neighborhoods like SoHo into a “shopping wasteland”.

Thanks in large part to their intransigence, commercial landlords who catered to retail tenants are being hit twice as hard as they otherwise would’ve been, as tenants, no longer able to afford rents higher than $600 per square foot, are now demanding concessions and rent reductions, a phenomenon that has seen average rents in certain neighborhoods plummet on a year-over-year basis.

According to CBRE Group, a real estate services firm that pays close attention to commercial rents in Manhattan, some of the hardest-hit neighborhoods are also some of the borough’s most trendy, including the Meatpacking District, and SoHo.

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Here’s an excerpt from the WSJ story, entitled “Retail Rents Plunge in Major Manhattan Shopping Districts”.

The average asking rent on Washington Street between 14th and Gansevoort streets in the Meatpacking District dropped to $490 a square foot from last year’s $623, a 21.3% decrease and the largest percentage drop in asking rents among the shopping corridors CBRE tracks.

Average asking rents tumbled 18.1% on both SoHo’s Broadway Avenue and the Upper East Side’s Third Avenue, where asking rents were $556 and $280 a square foot, respectively.

Availability remained flat compared with last year, with 209 ground-floor spaces marketed for direct leasing. The report noted, however, that landlords looking to directly lease space also will have to compete with sublease space, which has increased according to anecdotal reports. Some space available for sublease comes as retailers leave behind old quarters for better locations, Ms. LaRusso said.

Conditions are favorable for tenants, said Andrew Goldberg, vice chairman at CBRE. Landlords are more open to shorter-term leases and provisions allowing tenants to get out of leases if a retail concept doesn’t work.

“I think we will start to see some more of the savvier tenants of companies realize we’re starting to get to a point where they can drive some good deals for themselves,” Mr. Goldberg said.

The problem when rents enter free-fall territory is that it’s a self-reinforcing phenomenon (not unlike the blowup that triggered the demise of the XIV, but over a much longer period of time). As rents fall, retailers start wondering if they can procure a better deal, possibly in a better neighborhood. All of a sudden, landlords must now essentially compete with themselves as the number of subleases climbs.

Of course, Manhattan is Manhattan. There will always be hoards of boutique merchants, big-name brands and – well, Walgreens – clamoring for commercial rental space. 

But after nearly a decade of soaring real-estate valuations, it appears one of America’s hottest housing markets is heading for a “gully.”

On the other end of the property market, a drop in valuations and transaction volumes has inspired some observers to proclaim that “this is the breaking point.”

In short, we wish the Kushner Cos the best of luck as they prepare to buy out the remaining stake in 666 Fifth Ave. Because overpaying for commercial real-estate in Manhattan in 2018, nine years into one of the longest economic expansions on record sounds like a fantastic plan.

Source: ZeroHedge

Mid-November Chart Check

Still no sign of a rebound:

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Home prices rising about 6% annually and loans now growing at under 4% annually looks in line with at best flat housing sales:

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Looks like the blip up as hurricane destroyed vehicles were replaced has run its course:

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This had looked like it peaked a couple of years ago, but since went back up to new highs:

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By Warren Mosler | Investment Watch Blog

 

NYC Commercial Real Estate Sales Plunge Over 50% As Owners Lever Up In The Absence Of Buyers

So what do you do when the bubbly market for your exorbitantly priced New York City commercial real estate collapses by over 50% in two years?  Well, you lever up, of course. 

As Bloomberg notes this morning, the ‘smart money’ at U.S. banking institutions are tripping over themselves to throw money at commercial real estate projects all while ‘dumb money’ buyers have completely dried up.

A growing chasm between what buyers are willing to pay and what sellers think their properties are worth has put the brakes on deals. In New York City, the largest U.S. market for offices, apartments and other commercial buildings, transactions in the first half of the year tumbled about 50 percent from the same period in 2016, to $15.4 billion, the slowest start since 2012, according to research firm Real Capital Analytics Inc.

At the same time, the market for debt on commercial properties is booming. Investors of all stripes — from banks and insurance companies to hedge funds and private equity firms — are plowing into real estate loans as an alternative to lower-yielding bonds. That’s giving building owners another option to cash in if their plans to sell don’t work out.

“Sellers have a number in mind, and the market is not there right now,” said Aaron Appel, a managing director at brokerage Jones Lang LaSalle Inc. who arranges commercial real estate debt. “Owners are pulling out capital” by refinancing loans instead of finding buyers, he said.

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But don’t concern yourself with talk of bubbles because Scott Rechler of RXR would like for you to rest assured that the lack of buyers is not at all concerning…they’ve just “hit the pause button” while they wander out in search of the ever elusive “price discovery.”  

At 237 Park Ave., Walton Street Capital hired a broker in March to sell its stake in the midtown Manhattan tower, acquired in a partnership with RXR Realty for $810 million in 2013. After several months of marketing, the Chicago-based firm opted instead for $850 million in loans that value the 21-story building at more than $1.3 billion, according to financing documents. The owners kept about $23.4 million.

“The basic trend is you have a really strong debt market and a sales market that has hit the pause button while it seeks to find price discovery,” said Scott Rechler, chief executive officer of RXR.

The debt market has become so appealing that landlords are looking at mortgage options while simultaneously putting out feelers for buyers, said Rechler, whose company owns $15 billion of real estate throughout New York, New Jersey and Connecticut. That’s a departure for Manhattan’s property owners, who in prior years would pursue one track at a time, he said.

Of course, this isn’t just a NYC phenomenon as sales of office towers, apartment buildings, hotels and shopping centers across the U.S. have been plunging since reaching $262 billion nationally in 2015, just behind the record $311 billion of real estate that changed hands in 2007, according to Real Capital. Property investors are on the sidelines amid concern that rising interest rates will hurt values that have jumped as much as 85 percent in big cities like New York, compounded by overbuilding and a pullback of the foreign capital that helped power the recent property boom.

The tough sales market has put some property owners in a bind — most notably Kushner Cos., which has struggled to find partners for 666 Fifth Ave., the Midtown tower it bought for a record price in 2007. The mortgage on the building will need to be refinanced in 18 months.

Thankfully, at least someone interviewed by Bloomberg seemed to be grounded in reality with Jeff Nicholson of CreditFi saying that it just might be a “red flag” that buyers have completely abandoned the commercial real estate market at the same time that owners are massively levering up to take cash out of projects.

Some lenders view seeking a loan to take money off the table as a red flag, according to Jeff Nicholson, a senior analyst at CrediFi, a firm that collects and analyzes data on real estate loans. It may signal the borrower is less committed to the project, and makes it easier to walk away from the mortgage if something goes wrong, he said.

But, it’s probably nothing …

Source: Zero Hedge

Record Apartment Building-Boom Meets Reality: First CRE Decline Since The Great Recession

Even the Fed put commercial real estate on its financial-stability worry list.

No, the crane counters were not wrong. In 2017, the ongoing apartment building-boom in the US will set a new record: 346,000 new rental apartments in buildings with 50+ units are expected to hit the market.

How superlative is this? Deliveries in 2017 will be 21% above the prior record set in 2016, based on data going back to 1997, by Yardi Matrix, via Rent Café. And even 2015 had set a record. Between 1997 and 2006, so pre-Financial-Crisis, annual completions averaged 212,740 units; 2017 will be 63% higher!

These numbers do not include condos, though many condos are purchased by investors and show up on the rental market. And they do not include apartments in buildings with fewer than 50 units. This chart shows just how phenomenal the building boom of large apartment developments has been over the past few years:

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The largest metros are experiencing the largest additions to the rental stock. The chart below shows the number of rental apartments to be delivered in those metros in 2017. But caution in over-interpreting the chart – the population sizes of the metros differ enormously.

The New York City metro includes Northern New Jersey, Central New Jersey, and White Plains and is by far the largest metro in the US. So the nearly 27,000 apartments it is adding this year cannot be compared to the 5,400 apartments for San Francisco (near the bottom of the list). The city of San Francisco is small (about 1/10th the size of New York City itself), and is relatively small even when part of the Bay Area is included.

Other metros on this list are vast, such as the Dallas-Fort Worth metro which includes the surrounding cities such as Plano. Driving through the area on I-35 East gives you a feel for just how vast the metro is. However, I walk across San Francisco in less than two hours:

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Special note: Chicago is adding 7,800 apartments even though the population has begun to shrink. So this isn’t necessarily going to work out.

This building boom of large apartment buildings is starting to have an impact on rents. In nearly all of the 12 most expensive rental markets, median asking rents have fallen from their peaks, and in several markets by the double digits, including Chicago (-19%!), Honolulu, San Francisco, and New York City.

And it has an impact on the prices of these buildings. Apartments are a big part of commercial real estate. They’re highly leveraged. Government Sponsored Enterprises such as Fanny Mae guarantee commercial mortgages on apartment buildings and package them in Commercial Mortgage-Backed Securities. So taxpayers are on the hook. Banks are on the hook too.

This is big business. And it is now doing something it hasn’t done since the Great Recession. The Commercial Property Price Index (CPPI) by Green Street, which tracks the “prices at which commercial real estate transactions are currently being negotiated and contracted,” plateaued briefly in December through February and then started to decline. By June, it was below where it had been in June 2016 – the first year-over-year decline since the Great Recession:

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Some segments in the CPPI were up, notably industrial, which rose 9% year over year, benefiting from the shift to ecommerce, which entails a massive need for warehouses by Amazon [Is Amazon Eating UPS’s Lunch?] and other companies delivering goods to consumers.

But prices of mall properties fell 5%, prices of strip retail fell 4%, and prices of apartment buildings fell 3% year-over-year.

So for renters, there is some relief on the horizon, or already at hand – depending on the market. There’s nothing like an apartment glut to bring down rents. See what the oil glut in the US has done to the price of oil.

Investors in apartment buildings, lenders, and taxpayers (via Fannie Mae et al. that guarantee commercial mortgage-backed securities), however, face a treacherous road. Commercial real estate goes in cycles as the above chart shows. Those cycles are not benign. Plateaus don’t last long. And declines can be just as sharp, or sharper, than the surges, and the surges were breath-taking.

Even the Fed has put commercial real estate on its financial-stability worry list and has been tightening monetary policy in part to tamp down on the multi-year price surge. The Fed is worried about the banks, particularly the smaller banks that are heavily exposed to CRE loans and dropping collateral values.

But the new supply of apartment units hitting the market in 2018 and 2019 will even be larger. In Seattle, for example, there are 67,507 new apartment units in the pipeline.

Source: ZeroHedge

 

Seattle Has Most Cranes In Country For 2nd Year In A Row — And Their Lead Is Growing

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With about 150 projects starting this year or in the pipeline just in the core of the city, construction is as frenzied as ever.

(The Seattle Times) For the second year in a row, Seattle has been named the crane capital of America — and no other city is even close, as the local construction boom transforming the city shows no signs of slowing.

Seattle had 58 construction cranes towering over the skyline at the start of the month, about 60 percent more than any other U.S. city, according to a new semiannual count from Rider Levett Bucknall, a firm that tracks cranes around the world.

Seattle first topped the list a year ago, when it also had 58 cranes, and again in January, when the tally grew to 62.

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The designation has come to symbolize — for better or worse — the rapid growth and changing nature of the city, as mid-rises and skyscrapers pop up where parking lots and single-story buildings once stood.

And the title of most cranes might be here to stay, at least for a while. The city’s construction craze is continuing at the same pace as last year, while cranes are coming down elsewhere: Crane counts in major cities nationwide have dropped 8 percent over the past six months.

During the last count, Seattle had just six more cranes than the next-highest city, Chicago. Now it holds a 22-crane lead over second-place Los Angeles, with Denver, Chicago and Portland just behind.

Seattle has more than twice as many cranes as San Francisco or Washington, D.C., and three times as many cranes as New York. Seattle has more cranes than New York, Honolulu, Austin, Boston and Phoenix combined.

At the same time, Seattle’s construction cycle doesn’t look like it’s letting up. Just in the greater downtown region, 50 major projects are scheduled to begin construction this year, according to the Downtown Seattle Association. An additional 99 developments are in the pipeline for future years. And that’s on top of what is already the busiest-period ever for construction in the city’s core.

“We continue to see a lot of construction activity; projects that are finishing up are quickly replaced with new projects starting up,” said Emile Le Roux, who leads Rider Levett Bucknall’s Seattle office. “We are projecting that that’s going to continue for at least another year or two years.”

“It mainly has to do with the tech industry expanding big time here in Seattle,” Le Roux said.

Companies that supply the tower cranes say there’s a shortage of both equipment and manpower, so developers need to book the cranes and their operators several months in advance. It costs up to about $50,000 a month to rent one, and they can rise 600 feet into the air.

Most cranes continue to be clustered in downtown and South Lake Union, but several other neighborhoods have at least one, from Ballard to Interbay and Capitol Hill to Columbia City.

By Mike Rosenberg | The Seattle Times