Moody’s: Oil Slump a Moderate CMBS Credit Negative

Falling oil prices represent a moderate credit negative for commercial mortgage-backed securities collateral and will cause performance to deteriorate in some metros, said Moody’s Investors Service, New York.

But a number of mitigating factors should limit the harm, including limited CMBS exposure to oil metros, economic diversity in many oil metros, limited commercial real estate supply growth and generally strong property- and loan-level fundamentals, Moody’s noted.

“Oil slumps affect commercial real estate most directly by reducing demand for commercial space, typically occupied by oil-related employees,” Moody’s said.

In markets such as Houston and North Dakota’s energy-producing counties, construction driven by the oil boom inflated commercial real estate supply just as absorption began to decline. “This combined effect, on average, lowers occupancy rates and rents in energy metros, which is particularly stressful for loans with low debt service coverage ratios or those scheduled to mature in the near term,” Moody’s said.

Kroll Bond Rating Agency, New York, examined Houston’s performance and reported that falling oil prices shook up the nation’s tenth-largest office market. Houston ended 2015 with 13.5 percent vacancy in office properties, up 2.6 points year-over-year and the largest annual increase since 1999. The U.S. office sector averages 10.4 percent vacancy.

“[Houston] area vacancy levels have increased due to new supply and firm downsizings, which doubled the amount of available sublease space,” KBRA said. Nearly 90 buildings with 12 million square feet of office space delivered in Houston last year–15 percent of total U.S. deliveries. The city has another 8.7 million square feet under construction, the fourth-highest amount behind New York, Dallas-Fort Worth and Washington, D.C. Tenants had pre-leased only 63 percent of Houston’s space under construction as of year-end 2015.

“Although Houston’s economy is diversified as a result of the presence of the Texas Medical Center and the Port of Houston, KBRA believes low oil prices will continue to limit growth in the metro area over the near term as a result of the large amount of new office space that was recently added and/or is still under construction, the increasing amount of sublease space, continued mergers in the energy industry, and macroeconomic and political uncertainty,” the bond rating firm said.

Moody’s agreed that Houston–by far the largest oil metro–has a more diverse economy than in years past and can supplement loss of oil-sector tenant demand with growth in other industries, particularly those that benefit from low oil prices. “The smaller markets with higher energy employment concentrations, such as Williams County, N.D., are more vulnerable to declines in several asset types, including office, apartment and hotel,” Moody’s said.