Commercial Magazine

Buckle up for another bumpy ride

By Victor Whitman

As bad as 2020 was for the U.S. commercial real estate market, 2021 could be worse. One window into just how rough the year could be is visible in the recent struggles of commercial mortgage-backed securities (CMBS).

Some analysts, including Trepp, describe a harsh cycle of distress potentially playing out this year that was foreshadowed by CMBS performance. Unlike banks, CMBS lenders were aggressive last year in calling in the debt on delinquent loans.

“I’m in the ER room with all of these borrowers every single day, and seeing the panic and the distress and the life coming out of them for their investments,” says Ann Hambly, owner of 1st Service Solutions, which works on behalf of struggling owners of distressed properties tied to CMBS loans. “Some of them are losing everything.” 

I’m in the ER room with all of these borrowers every single day, and seeing the panic and the distress and the life coming out of them for their investments.

Not surprisingly, CMBS loans underpinned by retail and hotel properties fared worst last year. 

“I have one particular client who has invested all of his wealth in a bunch of hotels,” Hambly says. “So, he has a huge hotel portfolio and, you know, you would expect in your lifetime, maybe one or two will have a problem. But would anyone ever predict that all of them overnight would be closed?” 

As of this past September, more than one-quarter of all CMBS hotel loans and 18% of CMBS retail loans were in special servicing, the highest shares on record, according to Trepp. The 30-day delinquency rate for CMBS loans also hit an all-time high of 10.3% in June 2020, with lodging and retail delinquencies reaching 24% and 18%, respectively. 

Furthermore, Trepp identified more than 800 CMBS loans with a total volume of $32.1 billion that have been granted forbearances. This temporary relief has kept the delinquency rate lower than it would have been, particularly for the loans underpinned by hotel and retail assets. 

In an October 2020 podcast, Trepp analysts noted that several mall and retail owners handed their keys back to CMBS lenders over the summer. Some of these assets were sold at deep discounts. A mall in Burnsville, Minnesota, for example, was auctioned for $17 million. This property had a CMBS debt load of $67.2 million and appraised for $137 million in 2010. 

Manus Clancy, Trepp’s senior managing director and leader of applied data, research and pricing, notes that it has been hard to gauge property values using traditional appraisal methods. Recent CMBS auctions, however, provide a reasonable measure of what properties in the larger commercial real estate market might be worth now. The bids also show how steeply values have dropped. 

“If you are willing to sit there and watch the bids come in, it is a useful and more accurate level of valuation than you get out of appraised values,” Clancy says.

As of second-quarter 2020, CMBS debt and similar instruments represented a little less than 14% of the $3.7 trillion in outstanding commercial and multifamily mortgage debt, whereas banks held nearly 40%, according to the Mortgage Bankers Association. The market at large was mainly in a holding pattern last year. Sales and investment activity had fallen dramatically among all property types through October 2020, but aggregated asset values were still rising — and even hotel and retail asset values had not fallen significantly year over year at that time — according to Real Capital Analytics. 

Temporary financial relief for tenants and owners undoubtedly propped up the market last year and that support also will likely end in 2021. Once rent and mortgage forbearances end for tenants and owners, Trepp and other analysts say more problems will emerge. Struggling commercial tenants will eventually be handed 90-day notices to repay their back rent. Many won’t be able to pay. Evictions would then naturally rise and rental streams could dry up for the property owners who can’t immediately replace their former tenants. 

If and when these owners can’t pay their mortgages, lenders of all investor types could be forced to choose between two bad options — forgiving a chunk of the debt or taking back the notes. Ultimately, by year’s end, many more lenders could hold the keys to severely devalued properties that they will either have to keep on their books for years or sell at heavy losses. Lenders with the most commercial real estate exposure will be in trouble. 

K.C. Conway, chief economist for the CCIM Institute, says that the majority of hotel loans held by banks are on payment deferrals and lenders have yet to recognize the declines in value. Inevitably, he says, banks will begin sorting through bad loans and selling to opportunistic equity funds for about 40 to 50 cents on the dollar. He says that more than 100 banks with deep commercial debt exposure could fail in 2021. 

“There is a big day of reckoning coming for the banks, especially those that have a lot of commercial real estate holdings,” Conway says. ●


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