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Category ArchiveCMBS

CMBS Servicing Issues Still the Strongest Headwind to Growth

The Future of CMBS panel at the MBA’s CREF/Multifamily Housing Convention & Expo in San Diego was a lively debate between market participants, who agreed that 2017 was a solid year for the product and that risk retention was, well, much ado about nothing.

CMBS issuance reached $90 billion last year with single-asset, single-borrower issuance increasing by 80 percent to $38.5 billion and essentially moving the market—but the panel’s overall consensus was that issuance volume will be down in 2018. With that in mind, panelists discussed the sector’s current state of play and its strongest headwinds to growth.

Would an overhaul or repeal of the Volcker Rule—part of the Dodd-Frank Wall Street Reform and Consumer Protection Act and implemented in the wake of the global financial crisis in an attempt to reduce risk in secondary market trading—boost the CMBS market? Ted Borter, the co-head of the real estate financing group at Goldman Sachs, said no doubt, but there’s a bigger “mega issue” hampering the CMBS industry’s growth right now that must be tackled, stat: its servicing.

“It’s very frustrating to lose a deal to a life company because of CMBS servicing issues,” Borter said. “Borrowers prefer banks and life companies because of the servicing and also the certainty of pricing,” he said, adding that changing the borrower experience is “going to take time, but everyone in CMBS is making a huge effort.”

Dan Bennett, the head of capital markets at LoanCore Capital, said his firm is working hard to improve the borrower experience and expand the universe of those who transact in CMBS by actively playing various roles within a CMBS transaction. In addition to originating deals, LoanCore is a B-piece buyer and controlling holder. As deal-by-deal examples of happier customer service experiences are available, that too will help the industry grow, Bennett said.  

Freddie Mac has developed a servicing standard of its own and is “keenly focused” on the borrower experience, said David Brickman, the head of the agency’s multifamily division. Freddie Mac is also focused on improving the economics of the servicer so that servicers are incentivized to provide better customer service.

Brickman said that the ultimate benefit in improving the customer experience could be attracting higher quality borrowers and, consequently, investors to CMBS deals.

For now, Borter said he finds it “embarrassing” that requests to servicers take so long to be addressed, and Goldman Sachs is tackling the issue head-on in three ways.

First, it has a servicer liaison who receives all requests sent to the servicer so that Goldman Sachs is able to monitor responsiveness and whether servicers are abiding by timelines.

Second, it’s looking at servicer compensation. “As an industry we have rammed down servicing fees so you get what you pay for and the servicer ends up charging the borrower,” Borter said. “But if the servicing fees are upped, those nuisance fees will go away.”

Lastly, Goldman Sachs is focused on clarifying the language in servicing documents to make it easier on the borrower and looking at the removal of some of the (many) borrower touch points in a CMBS deal.

The number of parties written into pooling and servicing agreements that must weigh in or approve actions throughout the life of a CMBS deal can also complicate things and cause delays to borrowers, said Erin Stafford, the managing director of global CMBS at DBRS. For example, when the rating agencies are asked to opine on any change in conduit deals, “it can add two weeks to the [approval] process,” she said.

Once the source of much anxiety, risk retention—now 14 months old—has turned out to be “much ado about nothing,” Borter said. Its implementation has, however, further consolidated the business down to the top 10 issuers who have the balance sheet to hold that risk, he said.

Bennett agreed that there has been very little impact, except for a slight slowdown in the market while it figured things out.

The GSEs are exempt thus far from the risk retention rules, although that could change, Brickman acknowledged. For now Freddie Mac is focused on developing an increasing stable of B-piece buyers who understand Freddie’s product who are committed the space. “We will not sell to opportunistic investors,” Brickman said. “We’re looking for multifamily experts.”

Source: commercial

Partner ESI’s Bob Geiger Talks CMBS and Construction Risk

Bob Geiger is a principal at Partner Engineering and Science Inc (Partner ESI), based in the firm’s Chicago office. With more than 20 years of experience under his belt, Geiger knows a thing or two about engineering and environmental services. Partner ESI provides due diligence services to a wide variety of real estate lender and investor clients, so Commercial Observer caught up with Geiger in Miami last month to find out which group is keeping him busiest.

Commercial Observer: How was business last year for Partner ESI?

Bob Geiger: It was a strong year for the company and for the team that I run. We saw a lot of activity, not just on the financing side but also on the acquisition and disposition sides of the industry.

What primarily drove business?

CMBS was a surprisingly strong sector, we were particularly busy with single-asset, single-borrower transaction work. I think 2018 will also be a good year, although maybe not quite as strong as 2017—that’s the sentiment I’m hearing from the larger CMBS shops that my team does work for.

How big a chunk of Partner’s book of business does CMBS comprise?

Maybe 20 to 25 percent, which is higher than expected. Some of the transactions we worked on were for marquee-type assets—so the large, mega mall-type properties that some of the larger shops were financing—but there were also a lot of self-storage portfolio deals. Self-storage has been a very active property type for us, because self-storage facilities are being built on challenged properties in a lot of cases. It’s a nice use for a property that has environmental issues, but that means you have to work through these issues so those properties can be securitized.

What’s the biggest complexity in a self-storage deal?

I think the environmental aspect is the most challenging because there are typically historical environmental issues that we have to work through. We have to tie up all the loose ends and data gaps there may be in the paper trail regarding how historical issues have been addressed in the past. If some of them are left open, it’s a case of quantifying those issues based on existing data—ideally without having to do a Phase 2 [Environmental Site Assessment] or put holes in the ground—so that clients can move forward with a transaction. That’s where we try to be strong; quantifying potential concerns.

Are you hearing any concerns or frustrations on the construction risk management side?

We work with a regional construction lender who has expressed some frustrations about competing firms not imposing the same level of requirements on developers [that they do]. So, there are  signs that there’s a little looseness in places. We’re also seeing some lenders backing off from multifamily a little and hospitality in some cases. But, generally speaking, there’s still a lot of construction lending out there, and the work we do provides a greater comfort level to construction risk managers.

Where have you been busiest, on the construction risk management side?

We’ve been very busy on the affordable multifamily side in Chicago, working with developers on low-income tax credit deals. You end up with affordable housing that is much more effective, productive and high quality than if the government was doing it.

Did you make any personal resolutions for 2018?

I think I made about 20 of them—hopefully, some of them stick[laughs]. Professionally speaking, Partner is in a great place to continue to grow this year.

Source: commercial

Toys ‘R’ Us Bankruptcy Could Risk $500M in CMBS

The announcement of the closure of 182 Toys “R” Us stores last week—part of the retailer’s Chapter 11 bankruptcy filing last fall—has put roughly $500 million in commercial mortgage-backed securities (CMBS) at risk, according to a report from Morningstar Credit Ratings.

Analysts at the rating agency identified 20 CMBS loans, with a combined balance of roughly $500 million, that could come under fire due to occupancy concerns following the closings.

The report, issued on Tuesday, indicates that there are 40 CMBS loans—with a combined balance of $1.47 billion—that are exposed to the recent Toys “R” Us store closures. While 20 of those loans—with a combined balance of $500 million—are of concern due to occupancy issues following Toys “R” Us’ departure, the remaining 20 loans haven’t raised red flags due to the fact that Toys “R” Us doesn’t represent a large enough portion of each asset’s leasable space. Of the latter population, the two largest are the $56 million loan backed by Akers Mill Square in Atlanta, Ga., and the $123 million loan on The Plant at San Jose in San Jose, Calif.

The loan on Akers Mill Square was securitized in the Deutsche Bank-sponsored COMM 2014-LC5 transaction and represents 6.31 percent of its roughly $695 million securitized balance. The loan on The Plant at San Jose in San Jose, Calif.—securitized in the Wells Fargo-sponsored WFRBS 2013-C14 CMBS deal—constitutes 8.8 percent of the deal’s roughly $1 billion balance.

In September 2017—prior to the bankruptcy filing—a Morningstar Toys “R” Us risk report highlighted two of the largest CMBS loans at risk, should the retailer file for bankruptcy. The $507.6 million loan securitized in the Goldman Sachs/ Bank of America-sponsored TRU 2016-TOYS deal is the CMBS loan with the largest exposure.

Although the loan is backed by a portfolio of 123 Toys “R” Us and Babies “R” Us stores, Morningstar analysts noted that just seven locations with an allocated property balance of $3.2 million are exposed to a closing store and that the stores’ geographic diversity and low loan-to-value ratio (56.6 percent) significantly mitigates loan default risk.

Analysts also noted that the largest asset within TRU 2016-TOYS accounts for only 2.4 percent of the securities balance and that a small number of stores closing is unlikely to have a significant effect on the deal.

On Sept. 18, 2017, Toys “R” Us filed for Chapter 11 bankruptcy, making the toy store chain the latest retailer to feel the pressures of operating brick-and-mortar shops in an age of dominance for e-commerce and online shopping.

In an effort to restructure and reorganize in bankruptcy proceedings, Toys “R” Us announced on Jan. 23 plans to shutter 182 stores—or 20 percent of its U.S. portfolio, with about half of the stores falling under the Babies “R” Us brand—that have failed to meet “performance standards,” as Commercial Observer reported on Jan. 24.

A spokeswoman for Toys “R” Us previously told CO that the company had until Feb. 6 for the court to approve its plan to shutter it’s targeted locations. If approved, the closures would have commenced in January, with “the majority” closing in mid-April,  according to a letter on the company’s website to customers and signed by company CEO Dave Brandon.

Toys “R” Us was able to extend its the court-imposed deadline to decide which stores to close to the end of August, as part of a deal with creditors, Bloomberg reported on Jan. 23. In exchange, the company agreed to pay landlords’ fees related to the bankruptcy case as well as finish this round of store closures by the end of August or it will be unable to close any of the stores on its list until after the 2018 holiday season.

A representative for Toys “R” Us could not immediately be reached.

Source: commercial

Unilev Scores $90M Debt and Equity Recap for Wells Fargo Place

Beverly Hills-based Unilev Capital Corp. has received a $90 million debt and preferred equity package to recapitalize Wells Fargo Place—a 37-story office property in St. Paul, Minn., Commercial Observer can first report.

KKR provided a $70 million five-year, floating rate loan in the deal, while an unnamed preferred equity investor provided the remaining $20 million.

Iron Hound Management’s Christopher Herron and John Wood negotiated a resolution with C-III on behalf of Unilev and arranged the new debt and equity recapitalization, sources said. 

The 635,000-square-foot building was erected in 1987 and is located at 30 East Seventh Street in downtown St. Paul. At 471 feet, it is the tallest office building in the city’s central business district, according to Unilev’s website.

Unilev acquired the property, previously known as Minnesota World Trade Center, from Zeller Realty Group in October 2006, according to an article by the Minneapolis/ St. Paul Business Journal, paying more than $100 million.

Prior to the new financing, the property was still cash flowing and well occupied but required a recapitalization in order to pay off the previous debt, sources said. 

“Through the new financing, new capital partners and a successful recapitalization, Unilev was able to pay this loan off at par, which is not the norm,” one source familiar with the transaction told CO.  

Today, Wells Fargo Place’s government and state-driven tenants include include Minnesota State Colleges and Universities, the Internal Revenue Service and—of course—Wells Fargo.

Officials at KKR declined to comment. Officials at Unilev did not respond to a request for comment. Officials at Iron Hound confirmed their involvement in the deal but declined to comment further.

Source: commercial

CREFC 2018: Say Hello to CLOs

Commercial real estate collateralized loan obligations (CRE CLOs). It’s a bit of a mouthful for sure, and for some, CLOs are a sobering reminder of the pre-crisis Wild West. But, they’re baaack. And, judging by the packed house with standing room only that the CREFC panelists—including issuers, lenders and an investor—spoke to, people are curious about the new and improved 2018 CRE CLO market.

And for good reason: The market is heating up, significantly. Case and point, in December, Blackstone Group issued the largest CRE CLO post-crisis, the BXMT 2017-FL1 transaction, weighing in at a whopping $1 billion. The transaction was collateralized by 31 senior participation interests in loans secured by 71 properties, according to a report by KBRA at the time of the deal’s issuance.

Last year saw almost $8 billion in deal volume, but panelists estimate that amount will easily rise to $12 billion to $14 billion in 2018, driven partly by investor demand for the bespoke financing market. It’s a significant increase, given that in 2016 there was only $2 billion in issuance. That said, the market may be growing but remains disciplined and well balanced, one panelist said.

Today, CRE CLOs are a benign, nonrecourse source of financing that serve a distinct market purpose, panelists noted. Specifically, they solve the capacity issue around balance sheet financing. As an added bonus, when the market is functioning well, a CRE CLO is an accretive form of financing that complements warehouse financing nicely. Further, the deals create new capital markets opportunities and relationships for their participants.

First up in the panel discussion was the question of how recent CRE CLOs differ from CLOs issued pre-crisis. One panelist said that today’s CRE CLOs are “plain vanilla” unlike the more exotic pre-crisis days. But simply put, they have improved collateral quality. Pre-2007, the majority of transactions were more leveraged and the loans pledged as collateral had higher leverage attachment points. Today’s CRE CLOs are also composed entirely of first lien mortgages in contrast to pre-crisis collateral, which consisted of various position in the capital stack.

Most of the loans securitized in today’s CRE CLOs are floating-rate, short-term bridge loans on transitional assets where the sponsor is in the process of implementing a business plan on the property.

The notion that the loans included in the structures must always be cash-flowing is overstated, one panelist said. While generally true, the spectrum of loans in deals varies greatly and rating agencies are very pragmatic on how these loans are viewed. However, ground-up construction loans won’t make the cut.

Lenders also have more flexibility with CRE CLOs than they typically would in a REMIC structure, panelists said, with less servicing restrictions when it comes to modifying the loans. A key factor, given the transitional nature of the underlying collateral and the varying timelines of a borrower’s business plan implementation for those assets.

Tempted to dabble in the space and issue a one-off CRE CLO deal?

Proceed with caution, said participants. Significant resources are required from both an expense and labor perspective in order to pull a transaction together. From pooling the assets in an investor-friendly structure to working with the rating agencies and legal counsel to contending with extended transaction timelines and market volatility. The gestation period can take up to 15 weeks, and in a volatile market, the cost of funds targeted by an issuer can move significantly.  And don’t forget, CRE CLO issuances, like CMBS, are subject to risk retention requirements.

Something else to bear in mind if considering a single deal is that investors are typically more receptive to those who are in the market more frequently, panelists said.

Investors in the asset class areas alwaysresponsible for doing their homework. While one panelist had some concern that this isn’t necessarily always the case, evident in oversubscribed AAA tranches, another panelist argued that investors today are buying CRE CLO bonds based on diligence and underwriting as opposed to ratings—another key differentiation from the pre-crisis era.

One thing is pretty clear, with issuance expected to almost double this year, the use of CRE CLOs for transitional lending will continue for the foreseeable future.


Source: commercial

CREFC 2018: How’s CMBS Doing? KBRA’s Eric Thompson Fills Us In

CREFC’s annual conference at the Loews Hotel in Miami kicked off with an overview of how the CMBS market has been faring, courtesy of Eric ThompsonKroll Bond Rating Agency’s senior managing director. All eyes have been on CMBS with the financing source proving its competitiveness in 2017 and going up against bank and life company loans. Proof is in the pudding, and last year’s issuance volume neared $90 million, surpassing most analysts’ expectations.

Single-borrower issuance in particular increased by a whopping 88.7 percent in 2017 year over year to $36.5 billion, while conduit issuance remained flat at $48.5 billion.

KBRA expects single-borrower issuance to remain strong in 2018. “There’s a number of factors that might contribute to that,” Thompson told Commercial Observer between panels. “Some borrowers may be seeking to lock in a better rate than they currently have, do so ahead of rising interest rates and take some value accretion out of a property. It is also anticipated that M&A activity may spur acquisitions that result in capital market financings.”

There is also a couple of dynamics going on in the single-borrower space that make it appealing to market constituents, Thompson said: “One is that while it can be a very competitive market for pricing and execution for issuers that can lead to compressed profit margins, they can pre-place a lot of the debt with investors and have a good idea of where that execution might be. Two, I think there’s a deeper pool of subordinate buyers who are willing to buy further down in the capital stack because they’re comfortable with the credit on a single asset and comfortable in looking at their basis from the perspective of owning it. Unlike in a conduit deal, if things do go bad, you have more transparency into what conditions can effectuate a change in control as there is only one asset.”

KBRA is aware of a dozen or more single-borrower transactions coming down the pipeline as the year begins and expects to see up to three CRE CLOs issued by mid-February.

At 57 percent, 2017 appraisal LTVs were at their lowest since KBRA began rating conduits in 2012, which is both good and bad. “The issue is that when you have that level of leverage CMBS is competing more with insurers and banks. Even if banks pull back because of regulatory concerns, you have more competition than you would even if you had marginally higher leverage.”  

Historically a financing source dedicated to assets in secondary and tertiary markets, one interesting trend uncovered in KBRA’s research last year was CMBS’ increasing exposure to primary markets. “We found that primary markets default less than secondary markets by two to three points. When they do default, they have losses that are five points less than any other market,” Thompson said. “In the most liquid MSAs, the default rate is actually half that of other market tiers. So this is a positive credit element and a bright spot in terms of trends from prior years.”

CMBS loans in the largest, most liquid markets MSAs—New York, Boston, Washington, D.C., Chicago, Los Angeles and San Francisco—reached 33 percent in 2017, up from 28.1 percent in 2016. When combined with exposure to the next 11 largest MSAs, that percentage pierced the 50 percent level for the first time in KBRA’s rating history, reaching 54.3 percent (compared with 45.5 percent in 2016).

In his opening remarks, Thompson cautioned that, while primary market’s diverse economies can certainly withstand downturns, oversupply is always a concern to consider.

In terms of property types, 2017 was the year of the office with CMBS exposure to the asset class increasing to 39 percent. Perhaps unsurprisingly, retail exposure took a hit, dipping to 25.4 percent after averaging above 31 percent in previous years.

And while delinquency levels remain low, they are increasing. KBRA’s conduit portfolio delinquency rate reached 0.44 percent by year-end 2017, up from 0.15 percent at the end of 2016. The increase was somewhat expected given seasoning in transactions, Thompson said. Term defaults historically peaking between years four and six; the bulk of the delinquency (0.32 percent) is from the 2013 and 2014 vintages.

As one of the most buzzed-about topics at the CREFC conference, it looks like CMBS will continue to shine in 2018.

 


Source: commercial

2018 CMBS: The Rating Agencies’ Predictions

After a stellar 2017, what’s in store for CMBS next year? We asked the industry experts to opine…

 

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Erin Stafford. Jeff Wasserman/ For DBRS

Erin Stafford,  Head of North American CMBS at DBRS

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We are expecting volume to be flat compared to 2017. The lion’s share of the increase in U.S. CMBS volume in 2017 came from increased issuance in the single-asset, single-borrower (SASB) market, while the conduit market in 2017, after adopting risk retention, is likely to end up close to flat from the previous year. It is likely that the SASB volume could remain strong as many of those transactions are short-term in nature and may need to be refinanced into the CMBS market as interest rates remain low.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

We are seeing some softening in certain markets. For instance, Houston was on our radar prior to Hurricane Harvey as office vacancies in the energy corridor had increased in addition to lower hotel occupancies and higher concessions at higher-end multifamily properties. There are markets where new supply may cause short-term disruptions; this is particularly noteworthy for hotels. Regional malls are something that we are watching very closely especially since last year retailers were quick to make store closure decisions following disappointing holiday sales, and we expect this again in 2018. We notice that some mall operators are making great strides to upgrade their offerings while others are lagging, seemingly awaiting more store closures. Other areas we are paying close attention to are suburban office projects and student housing properties.

 

James Manzi, Senior Director at S&P Global Ratings

jmanzi 2018 CMBS: The Rating Agencies’ Predictions
James Manzi. Photo: Standard & Poor’s

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We’re expecting about $85 billion in CMBS issuance next year, which is slightly lower than this year’s total, which we expect to be around $90 billion. Lower CMBS loan maturities are a headwind, while continued activity in the single-borrower space and the potential for more multifamily collateral making its way into conduits are tailwinds.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

With offices taking a leading role in conduits in the 2017 vintage (at around 40 percent of collateral) and being second only to lodging in terms of volume securitized in single borrower deals, we’ll be closely watching performance in that sector. It will be interesting to see if companies (office tenants) choose to use smaller footprints over time, similar to the way retailers have reduced theirs.

 

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Zanda Lynn. Photo: Stefan Falke/ For Fitch Ratings

Zanda Lynn and Huxley Somerville, Head of U.S. CMBS Business Development and Head of U.S. CMBS at Fitch Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

Zanda Lynn: Our projection for non-agency CMBS is approximately $75 billion for 2018. We expect the slowdown in commercial real estate activity to contribute to a decline in overall volume, though the single-borrower market looks strong.

 

huxley somerville 3 2018 CMBS: The Rating Agencies’ Predictions
Huxley Somerville. Photo: Stefan Falke/ For Fitch Ratings

 

 

 

Are there any property type or regions that you are paying close attention to as we go into the new year? Why?

Huxley Somerville: Hotels, while continuing to perform, are showing signs of slowing revenue growth especially in New York City where new construction is adding to underperformance. We do not believe current revenue levels are sustainable over the longer term.

 

larry kay kbra senior director 2018 CMBS: The Rating Agencies’ Predictions
Larry Kay. Photo: KBRA

 Larry Kay and Eric Thompson, Managing Director and Senior Managing Director at KBRA

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

While we are forecasting that CMBS private label issuance will decline from 2017 levels, there is still good support for new issuance as many positive CMBS and CRE underpinnings remain intact. Interest rates are still historically low, CRE provides favorable returns compared to other asset classes, CRE capital flows while slightly down are still strong, and credit performance remains stable. However, a potential market disruptor could be if the market believes that the Federal Reserve’s balance sheet unwinding is taking too much liquidity out of the system; this could trigger a jump in, or more volatile, interest rates. In addition, investors may be more cautious in their CMBS and CRE allocations in 2018 as property values are beginning to feel stretched, and a decline in scheduled maturities may limit refinancing opportunities. As a result, we are forecasting $65 billion of private label issuance in 2018, which could end up being 25 to 30 percent lower than 2017 levels.

eric thompson kbra senior managing director 2018 CMBS: The Rating Agencies’ Predictions
Eric Thompson. Photo: KBRA

 

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

In addition to concerns regarding full-price department stores, in 2018, we will be watching their off-price formats very closely. Chains that report sales with off-price department store offerings include Nordstrom Rack, which just reported fiscal 3Q 2017, and Saks Off Fifth with reported fiscal 2Q 2017 numbers. Both experienced declines in same-store sales performance for each respective quarter and through the nine and six months ending October and July 2017. Declining sales in what has been a high-growth segment leads us to believe there could be sales cannibalization and brand dilution taking place.

Historically, the underlying assertion was that department store retailers would not open off-price stores close to their full-line brand if it cannibalized sales. Based on KBRA’s analysis, which used Nordstrom financial disclosures, the distance between Nordstrom Rack and the retailer’s full-line offerings will increase in the future. Of the existing stores, approximately 42 percent of the off-price locations were situated within five miles of the nearest full-line store—the comparable figure for scheduled openings is just 17 percent. Perhaps this has to do with the availability of real estate. However, it could also signal that the retailer is trying to mitigate the potential for cannibalization and brand dilution.

img 1976 edit 2018 CMBS: The Rating Agencies’ Predictions
Lea Overby. Photo: Kaitlyn Flannagan/ For Commercial Observer

Lea Overby, Head of CMBS Research and Analytics, Structured Credit Research and Ratings at Morningstar Credit Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We expect 2018 nonagency issuance of $70 billion to $75 billion, down slightly from this year’s full-year total of around $85 billion. We are also likely to see another $100 billion in agency issuance next year. The volume of maturing loans that must be refinanced in 2018 will be far lower than in 2017, and most maturing loans are with portfolio lenders, rather than in CMBS. In fact, only $24 billion in CMBS will mature next year, down from over $80 billion that matured in 2017.

Despite the dip in maturing loan volume, we believe that lending may remain relatively constant. We expect transaction volume to remain steady, and borrowers may prepay loans to get ahead of potential interest rate increases. Also boosting CMBS issuance, conduit lenders may become more competitive with balance sheet lenders because conditions in the capital markets remain favorable with tighter CMBS spreads and low volatility. 

Are there any property types or regions that you are paying close attention to as we go into the New Year? Why?

Even though we believe that talk of the retail apocalypse is overblown, we do have concerns for this sector. We expect to see another round of bankruptcies and store closures after the holiday shopping season, and this will likely result in higher vacancy rates in 2018. We will also be keeping a close eye on grocery-anchored space. We believe this sector will see further consolidation, as Amazon’s purchase of Whole Foods and the U.S. expansion of discounters, such as Aldi and Lidl, affect traditional grocers.  Aside from the retail sector, we are also watching the multifamily and hotel sectors. Both have done extremely well during this economic cycle, but the party might not last too much longer. We are seeing signs of overbuilding in certain markets, which may leave multifamily properties and hotels more vulnerable to changes in the economic cycle. There are indications that the stable economy may at last be leading to rising homeownership rates, which may hurt apartment performance. On the other hand, the hotel sector is always vulnerable to economic downturns, and this is exacerbated by increased supply.

Keith Banhazl, Managing Director, Moody’s Investors Service

keith banhazl moodys 2018 CMBS: The Rating Agencies’ Predictions
Keith Banhazl. Photo: Moody’s Investors Service

What does 2018 hold in store for CMBS?

The credit quality of newly originated and outstanding commercial mortgage-backed securities conduit and fusion loans will remain steady in 2018. Rising interest rates and a cyclical inflection point in the commercial real estate cycle pose some challenges to CMBS collateral performance, but declining leverage and increasing coverage in conduit loans provide some degree of protection. Further, the wave of maturing and aggressively underwritten loans from the 2006 and 2007 vintages has mostly come and gone, and we expect the overall delinquency rate to improve as the volume of newly issued CMBS 2.0 loans outweighs that of delinquent CMBS 1.0 loans.


Source: commercial

Chicago Office—Suburbs’ Losses Are Downtown’s Gains

Chicago, America’s third-largest office market with over 470 million square feet, exemplifies the nationwide trend of companies relocating to urban areas from the suburbs as young people and knowledge workers congregate in city centers. The Windy City is the largest in the Midwest and differs from its smaller neighbors with its vibrant central core, strong public transportation network and amenities that are attractive to younger residents. Despite population losses in the metro area, downtown Chicago gained over 42,000 residents between 2010 and 2015, according to the U.S. Census Bureau. Some of these gains, however, have come at the expense of its suburban neighbors. In fact, the city reports stable office vacancy of around 13 percent since 2015, but vacancy in the suburbs is much higher.

Beam Suntory, one of the world’s largest spirits producers, and Sara Lee Corp. have traded in their suburban offices for downtown Chicago, and McDonald’s and Motorola Solutions are following suit with planned moves in the next year. The biggest blow outside of the city was dealt to the Schaumburg area, which saw AT&T surrender 1.3 million square feet. The former AT&T campus in Hoffman Estates is a real estate-owned asset of two CMBS trusts, MSC 2006-T21 and BSC 2006-PW11, with a forecast loss of over $70 million. Average vacancy in the Schaumburg area was 21.1 percent as of November, according to CoStar Group. The only major gain for the suburbs in this time was when Caterpillar, which spent over 100 years in downstate Peoria, Ill., moved its operations north to suburban Deerfield in early 2017.

In the other large suburban office markets, Central North and Western East/West Corridor, the average vacancy rate is nearly 16 percent, up from a pre-crisis low of 9.2 percent, with high four- and five-star sublease availability of more than 25 percent between the two. In addition to ConAgra, a number of companies either moved their headquarters or relocated a significant portion of their work force from the Central North submarket to Chicago, including Walgreens, Allstate and Sterling Partners.

In addition, since 2009, many companies have relocated to Chicago from out of state, bringing thousands of jobs and increasing the demand for office space. These include ConAgra Brands, a packaged-food giant that moved its headquarters from Omaha, Neb., in 2016, and the Kraft Heinz Co., which shuttered the Madison, Wis., headquarters of its Oscar Mayer division and established a co-headquarters arrangement between Pittsburgh and Chicago.

Rising demand has led to an increase in office construction in the city. Developers delivered two office towers of over 1 million square feet each in early 2017, River Point and 150 N. Riverside Plaza, and the John Buck Co. is building an 820,000-square-foot office tower for CNA Financial. With its size, Chicago is unique for the region in that the addition of two 1-million-square-foot office towers will have a relatively modest effect on vacancy and rent. In fact, CoStar forecasts a vacancy rate of 13 percent for 2019 for the metro area, 100 basis points lower than at the start of 2017. .

The West Loop could be the greatest beneficiary of growth in downtown Chicago. With technology employers including Google, Gogo and Glassdoor taking space in the area and the nearby Fulton Market’s transformation from a meatpacking district to a restaurant mecca, millennials have made the West Loop one of Chicago’s trendiest neighborhoods.

Morningstar believes that Chicago’s ongoing migration of younger residents to the central core will continue to attract employers to the area. While there will still be a need for suburban office space, the lack of construction in those areas and weaker access to public transit may dampen growth. Consequently, we expect growth in these areas to be more modest.

Steve Jellinek is a vice president of CMBS research and Edward Dittmer is a senior vice president of CMBS credit risk services at Morningstar Credit Ratings. They can be reached at steve.jellinek@morningstar.com and edward.dittmer@morningstar.com.


Source: commercial

One Year Later, Risk Retention Is a ‘Nice to Have’ Feature for CMBS

Risk retention in U.S. CMBS will be one year old later this month. In 2017 (through Oct. 31), Fitch has rated 40 multiborrower CMBS transactions with risk retention. What has changed compared to previous years?

Structurally, average credit metrics like debt service coverage ratio (DSCR) and loan-to-value (LTV) have improved since 2015. Reflecting the improvement in credit, Fitch’s
BBB- credit enhancement has decreased during the same timeframe.

A big factor in the improvement in credit is the influx of investment-grade loans in 2017 transactions. Investment-grade loans receive a credit opinion from Fitch. Typically, they are large loans on high-quality properties with conservative debt levels. Fitch provides a credit opinion at BBB- or higher, analyzing it as if it were a standalone deal. In 2015, 4 percent of the loans in CMBS conduits were investment grade, whereas so far in 2017 that proportion is over 11 percent. In other words, an additional 7 percent of today’s transactions, on average, do not need credit support at BBB-. This means the decline in credit enhancement is exaggerated by the number of investment grade loans in 2017 deals. The improvement in credit remains even if you strip out investment grade and low-levered co-op loans.

This improvement may be a result of risk retention. However, Fitch would posit that a more important reason goes back two years to the introduction of Regulation AB. What this regulation effectively accomplished was to reduce by half the number of originators supplying loans to CMBS. This has allowed the remaining originators to hold their credit line because the borrower is unable to go around the corner to another originator and get better loan terms.

Not all credit metrics have improved in the last three years. Fitch’s cash flow haircut, for instance, has continued to increase. Cash flow haircut is the difference between what the originator determines is available to pay debt service and what Fitch determines, incorporating, among other things, adjustments for above-market occupancies and rents, as well as allowances for tenant improvements and leasing commissions. The haircut went from 9.6 percent in 2015 to 11.3 percent this year. Interest-only loans have also continued to increase. Full-term interest-only loans have almost doubled in the past two years and currently stand at 44.3 percent. In contrast, partial term interest-only loans have declined to just under 30 percent. Interest-only loans in any form now make up 73.6 percent of a deal, up from 66.4 percent in 2015. These trends are also repeated when the investment grade, and co-op loans are stripped out.

Of the 40 loans reviewed with risk retention, there is an equal split between vertical, horizontal and L-shaped structures; L-shaped has 12 deals, horizontal 13 and vertical 15. There are some differences in the credit metrics among the three structures though. Typically, L-shaped structures have better credit characteristics. Both Fitch DSCR and LTV on the L-shaped structure are slightly better compared to the vertical and horizontal structures. Fitch cash flow haircuts on the three structures are all between 11 percent and 11.5 percent. Additionally, there tend to be more interest-only loans in CMBS with the L-shaped risk retention structure compared to horizontal and vertical.

Why do L-shaped structures have the best, or close to best, credit metrics? It all comes back to investment-grade loans. L-shaped transactions have 15.4 percent of loans classified as investment grade. Vertical has just 8.4 percent and horizontal 12 percent.

So one year after the rules became official, has risk retention improved CMBS credit? Certainly, the risk retention deals of this year have better credit than the 2016 and 2015 deals that didn’t. That said, risk retention is more of a “nice to have.” If competition to make CMBS loans increases to the point that credit metrics worsen, then risk retention, and higher credit enhancement from Fitch, may provide the brake on what might otherwise be further declines in credit.

Huxley Somerville is the head of U.S. CMBS for Fitch Ratings. He can be reached at huxley.somerville@fitchratings.com.


Source: commercial

Regional Malls Look to Reposition as Retail CMBS Space Sweats

The e-commerce contagion has pulled brick-and-mortar retailers, regional malls and shopping centers under the weather, resulting in tenant bankruptcies and mass store closures that have, in turn, put pressure on maturing retail commercial mortgage-backed securities loans predominantly those issued in 2006 and 2007, prior to the financial crisis—and created refinancing hurdles for borrowers.

“The concern is everywhere, and in some cases, it’s a surprising reality,” said Manus Clancy, a senior managing director at Trepp. “Because of the outlook for retail in general, a lot of borrowers are struggling to refinance. The problems are across the sector.”

From November 2016 to October 2017, roughly $29.3 billion in securitized mortgages backed by retail properties were paid off or liquidated, 12 percent of which was disposed with losses, according to data from Trepp. The disposed loans were written off at an average loss severity of just under 55 percent, up from around 47 percent in 2016, while overall CMBS loss severity for all loans disposed within the same time frame fell to just under 43 percent. This year, there have been 244 retail loans—totaling $3.4 billion—that have been resolved with losses at around $1.8 billion, according to data from Trepp and Morningstar Credit Ratings.

“If I had to guess, [retail loss severities] are in excess of 50 percent,” said Andrew Hundertmark, a managing director at CWCapital Asset Management. “In my opinion, a mall was never worth what it was when the loan was made. There were assumptions made to rent growth and tenant strength that didn’t turn out to be true, and 10 years ago then these loans were made, no one saw Macy’s as a troubled retailer. J.C. Penney showed some cracks but wasn’t a concern. People underwrote loans thinking everything was going to stay as it was.”

The rest is history. Retail giants such as J.C. Penney, Sears and Macy’s have closed hundreds of stores as they try to shift investment focus to e-commerce, technology and the use of delivery services. On Nov. 2, Sears announced that it plans to close more than 60 locations by late January 2018, marking 243 total closures since January 2017. The retailer will be left with around 680 stores operating in the U.S., down from 3,500 locations in 2010.

What impact have these closures had on maturing retail CMBS? These loans have been made vulnerable, in part, because they’re propped up by leases from major anchor retailers. When anchor boxes come under increased stress or shutter, it creates a vicious cycle for the mall owner or landlord that can negatively affect overall consumer traffic to small- and midsized in-line retailers such as Radio Shack or Bon-Ton Stores—both of which have recently closed stores—who fill out the mall and benefit from a strong anchor presence.

“The best we can do [as servicers] is try to stabilize tenancy and get them in longer-term leases,” Hundertmark said. “We want leasing arrangements with tenants who can take advantage of co-tenancy if anchors close. Just because you have a mall that’s troubled, it doesn’t mean there aren’t retailers ready to come in. They’re all about traffic counts, and they don’t care so much if Sears is open for business or not.”

Chattanooga, Tenn.-based REIT, CBL Properties’ Mall of Acadiana in Lafayette, La., may be a transitionable survivor. Its debt was originated by Bank of America in 2007, and the loan comprises 63 percent of the roughly $196 million BACM 2007-2 CMBS transaction. The enclosed mall at 5725 Johnston Street was previously anchored by the usual suspects: Sears, J.C. Penney, Dillard’s and Macy’s. According to Trepp watchlist commentary, Sears will shutter its location at the mall by the end of the year, and “there are significant co-tenancy implications tied to the two anchors closing, which may have a significant negative impact on cash flow and potentially collateral occupancy.” The mall is buoyed by its collection of noncollateral tenants such as a Carmike movie theater, which occupies 247,072 square feet—or roughly 81 percent —of usable space, an Old Navy, a Barnes & Noble, an Olive Garden and a Taco Bell. As of November, Trepp commentary indicated that the borrower is “self-managing and leasing the mall and continuing to make monthly payments” despite the mall’s status as nonperforming beyond maturity.

Some major high-end national mall landlords, such as Washington Prime Group or GGP, look to reposition retail space to include entertainment and lifestyle services and national restaurants. Washington Prime has even moved to use online competitor Amazon’s fulfillment lockers to help draw consumers.

“Often, the property will be sold at auction for a discounted price, and now, at lower basis, the new owner can invest and turn them around. It’s a mixed bag,” said Edward Dittmer, a senior vice president of CMBS at Morningstar Credit Ratings.

Smaller entities may not be so lucky or may not have the capital necessary to make a change, being that repositioning an anchor into an entertainment venue or fitness center can be a daunting task. It can sometimes be an even harder challenge as malls in metro areas and gateway cities are just simply outdated and face competition from newer facilities complete with more modern amenities.

westside pavilion interior 2008 Regional Malls Look to Reposition as Retail CMBS Space Sweats
Interior view of West L.A.’s Westside Pavilion mall. Photo: Wikipedia Commons

Los Angeles’ Westside Pavilion is one recent victim of an oversaturated market. The future health of the three-story, 766,608-square-foot mall at 10800 West Pico Blvd. in the suburbs came into question in August after its debt service coverage ratio fell below 1.10x as it faced hurdles with lease terminations—major tenants have begun moving just a few miles away to the Westfield Century City mall.

“West L.A. has too many malls chasing the same customer and it was due for consolidation,” said Macerich Chief Executive Officer Art Coppola—Westside Pavilion’s owner—in the company’s third-quarter earnings call. In October, Macerich, announced its search for a buyer. The $142 million, post-crisis era loan was transferred to special servicer Rialto Capital Advisors for the first time in September due to imminent monetary default. The note comprises just under 13 percent of the remaining collateral in the roughly $700 million WFCM 2012-LC5, Wells Fargo-sponsored CMBS transaction.

“[Many borrowers] view retail as undervalued and come in at a good basis with a plan and some money and an opportunity to make some good return,” Hundertmark said. “In general, people are out there trying to sell the troubled stuff. Regional malls attract a much different buyer set. Strip malls or shopping centers tend to bring in more local buyers, those who know the market and may have owned the property next door and can bring some synergies there with repositioning. The buying universe really differs, and there are a couple names in almost all sales.”

CMBS retail issuance has climbed while delinquencies have fallen 16 basis points to 6.47 since August, Trepp data shows. Changes in the way retail space is being modeled and used have most certainly spurred new investment into the sector and enabled many operators to thrive despite widespread concerns over the performance of the physical retail environment.

“A lot of the new delinquencies we’ve seen have been maturity defaults in 2017 as a result of the 2007 issuance,” Dittmer said. “Some of those loans have not been liquidated yet and are going to take some time to work through. It may take a year or two to see what will be the ultimate resolution.”

Retail delinquencies recovered more quickly than other major property types after the most recent financial crisis, according to Trepp analysts. Special servicers acted more swiftly to foreclose on distressed retail collateral to cut losses, in contrast to the “extend and pretend” approach more commonly employed with other property types, analysts said.

“We’ve talked to a lot of landlords, and most of them are scratching their heads because every location is different,” Hundertmark said. “If we can get a gym in here and a couple of nice, national restaurants, the community is strong enough, so we can keep this moving. But, retail has moved away from us, so what can we do? We can partner with or sell to a multifamily developer to put up a new development. The old retail paradigm has been shattered. There is no one size fits all.”

GGP, a Chicago-based publicly traded owner and operator of high-end malls, has sought to survive retail market headwinds by renovating former department store boxes into restaurants, supermarkets and movie theaters. Meanwhile, GGP is considering a takeover bid by Brookfield Property Partners.

“[Landlords] have got more flexibility and more options than a servicer, and [they’re] definitely getting more creative and more aggressive, taking steps they’d never dreamed of 10 years ago,” Hundertmark said. “The model was you build the mall, and the anchors stores build around you.” That’s no longer the norm as landlords can no longer rely on anchors and must take matters into their own hands.

Some analysts argue that yield can be mined easily in the right market with the right strategy. “The bright side is pruning season is ending,” Clancy said. “Sears and Macy’s have been pruning and closing stores, but what’s left in their portfolio they’re confident in. Simon Property Group and GGP and others who provide experience can still make the business model work. The headlines have outpaced reality. People can still make a good buck with the right strategy, market and tenants. What’s disastrous is older malls, sagging demographics and newer competition.”

National mall landlords who can reposition these assets may be the future of regional malls as they’ve been able to exhibit the clout and capital needed to entice bondholders and take on such projects. And, these companies, like GGP, have seen its stock price climb in recent months.

There’s an interesting variety of players at auction for distressed regional malls, ranging from major national mall landlords to development firms looking to use the typically stellar locations where malls have been built to construct lifestyle centers full of national retail brands and restaurants, along with a residential building to help drive foot traffic and spark cash flow.

“First things we look for from a borrower is do they have the desire and the capital to reposition this mall, and three, do they have a plan?” Hundertmark said. “If they don’t know what they’re doing with the capital, they’re wasting everyone’s time. More and more we’re seeing them come in with a plan and turn it into a discount strip center or what have you.”

With approximately 25 percent of the CMBS arena being retail and roughly $3.1 billion in retail CMBS set to mature in the next 12 months, many borrowers may be done wiping their noses and ready to lick their chops.


Source: commercial