Distressed Debt Monitor: Special Situations in Commercial Real Estate

(Andrew Foster is MBA Associate Vice President of Commercial/Multifamily Policy; he can be reached at afoster@mba.org).

As economies reopen against a backdrop of decreased consumer demand and continued government relief, commercial real estate investors are grappling with a double-edged sword: defending certain existing challenged debt and equity positions on one hand and seeking new opportunities given shifted market dynamics.

The monthly snapshots of commercial mortgage-backed securities performance indicators such as watchlists, delinquency and defaults tell a story that varies and extends across the marketplace of various sources of capital with retail and hospitality asset classes playing the leading roles in terms of challenged asset types at this early stage.

Fitch Ratings noted in mid-June that, “commercial mortgage-backed securities loan transfers within the last 90 days represent more than double the level of specially serviced loans at year-end 2019.” Coming off multiple years of loan dispositions exceeding new loan transfers, special servicers took in 473 CMBS loans totaling $21 billion already in 2020. On the flip side, there are clearly a large number of potential buyers ready to acquire potential assets in the current market environment as opportunities arise.

Trepp CLO/CMBS Analyst Jyoti Yadav said the delinquency and special servicing rates for lodging have risen at a rapid pace for the 3,000 CMBS loans totaling $86 billion in outstanding balance. She noted early data in June based on 85 percent of private-label CMBS loans reported show a lodging delinquency rate of 24.44 percent, up from 19.3 percent in May and 2.71 percent in April. Click here for further breakdowns across product type.

MBA hosted a call Tuesday, June 30 featuring subject matter experts highlighting their views on Special Situations in Commercial Real Estate. MBA Capital Council Chair Gregg Gerken introduced the topic and Steven Schwartz, Managing Director with H.I.G. Capital, LLC/Bayside Capital, moderated the conversation. Participants included Starwood Property Trust Chief Originations Officer Dennis Schuh, JF Capital Advisors CEO Jonathan Falik and J.P. Morgan Managing Director Jeremy Hellinger.

 Discussion Topics and Key Takeaways:

• Current market color and outlook for delinquent and distressed loans
• Details on niche property types or situations such as hospitality and retail
• What players and capital are actively participating in the space
• Latest developments related to COVID-19

–Speakers expressed observations with respect to what the last three to four months have looked like from their respective roles at various types of institutions active in commercial real estate investment and lending.

“This wasn’t anybody’s fault,” one participant said. “This came out of nowhere. It was like the Global Financial Crisis in about three weeks. So we definitely played defense, worked with our borrowers and modified deals. I’d say most were concentrated in the hospitality sector.”

Another speaker noted some “pre-COVID” deals made it over the finish line, but said after that little happened for 60 days.

“While your average investor might expect a situation like the current pandemic to provide fertile opportunity for distressed investors aside from short-term opportunities with some forced securities selling in March with well-publicized margin calls, those opportunities have not materialized thus far in significant quantities,” one participant said.

In the hospitality sector, there was broad agreement that challenges abound with an uneven recovery anticipated with substantial performance variation across demand segment, market and product type. This is already being seen in reported occupancy percentage increases for drive-to weekend travel markets outside large dense urban areas (although some reported numbers may be deceptive if they are not including closed hotels in their supply counts).

“What’s different about hospitality versus other property types is hospitality is a true operating service business sitting on top of a piece of real estate,” one speaker said. “So by the end of March there was single-digit occupancy when travel and leisure came to a halt and many groups cancelled. To put that in perspective, if you have multifamily investments, you still have tenants. Many of them will still pay rent, like with offices. In hospitality-land we live in an entirely different world where our inventory turns over and prices and occupancy reset on a daily basis.”

For comparison, in 2001, just after 9/11, the hotel sector saw revenue per available room (the hotel occupancy rate times the average daily rate) decline 6.7 percent. In 2009, there was a nearly 17 percent RevPAR decline, the worst since the 1930s and the Great Depression. CBRE and STR now forecast a 50-plus percent RevPAR decline, several times that the sector saw after 9/11 and the Global Financial Crisis.

“It remains the first inning for hospitality,” one analyst said. “While there is not great information available in the private markets, public markets regularly have quarterly earnings. Reporting in May for Q1 2020 contained very little COVID impact; however, second and third quarter earnings will be telling as to what dynamics are like in terms of various profitability measures and market outlooks.”

Though challenges tend to grab the headlines, certain asset types are performing relatively well. One speaker cited the apartment and industrial sectors as notable examples.

MBA will continue to follow the various threads in this conversation with insights and content highlighting industry expertise as the CRE finance markets evolve for the balance of 2020 and beyond. Whether it’s sub-performing, scratch-and-dent, non-performing loans or distressed debt with a real estate component, market participants need to know who’s buying, who’s selling and what the latest developments mean for their businesses.