Moody’s Sees ‘Drastic Drop’ in CMBS Supply-Demand Fundamentals

Moody’s Investors Service, New York, said the supply and demand outlook for most property types in the securitized commercial real estate market fell “drastically” in the first quarter.

The overall composite score in Moody’s Red-Yellow-Green quarterly assessment fell from green 68 in late 2019 to yellow 46 in the first quarter. Composite scores were yellow for all property types except for retail, in the red zone at 31, and hotel, deep in the red zone with a 0 composite score.

The multifamily composite score decreased 28 points to yellow 56, the lowest for the sector since Moody’s launched the report. Of the 66 markets studied, scores improved in three and decreased in 63 markets.

The retail sector’s score decreased 47 points from green 78 in late 2019 to red 31, also the lowest score since the report began. Scores deteriorated in every market studied. The sector’s supply-versus-demand relationship deteriorated greatly, Moody’s said.

Office performance varied by location. The central business district office score decreased from green 69 to yellow 56, the lowest score since second-quarter 2010. The suburban office score decreased 14 points to yellow 46 as the first-quarter vacancy rate increased.

The industrial composite score continued its decline for the third straight quarter to yellow 51 from green 69 in the prior quarter, falling out of Moody’s green territory for the first time since 2014. Scores improved in seven markets, deteriorated in 54 and were unchanged in two markets.

The hotel composite score fell to red 0 from yellow 49 in the prior quarter. “All individual market scores have fallen to red 0,” Moody’s said. The overall market now trails its baseline revenue per available room target by 21.5 percent after leading its target by 4.5 percent in the previous quarter. The supply versus demand relationship deterioration was driven by cratering demand for room nights.

Kroll Bond Rating Agency, New York, said it expects many borrowers with CMBS loans due to mature through 2021 will face a “challenging” refinancing environment due to current economic conditions. “While we expect that many maturing loans could become nonperforming, we also anticipate seeing numerous maturity extensions and other forms of modifications, particularly where borrowers may be facing challenges due to liquidity and/or tenancy issues,” said KBRA Senior Director Larry Kay.

The KBRA report, Rating Considerations for Maturing CRE Loans in a Challenging Environment, called the total balance of loans maturing through 2021 “relatively modest” at $4.7 billion. But while the volume of loans pending maturity through 2021 may be modest, there are 15 conduits that have near-term maturity exposures of 10 percent during this period. In addition, KBRA identified 39 loans totaling $20.3 billion across 33 single asset-single borrower and large loan deals with maturities through 2021.

Kay said analysts consider several factors when looking at outstanding rating and loan maturity risk, including the cause of default and workout strategy, how the property is performing prior to the maturity as well as asset quality, property value, current economic and capital market conditions and sponsorship. “If these factors are trending negatively or a cause of concern, downgrades are more likely,” he said. “In conduit transactions, the concentration of the maturities, especially if there are a number of underperforming loans, will play a factor in determining if rating actions are warranted. Additionally, transaction structure and features such as credit enhancement levels and servicing advances or potential for interest shortfalls are considered. Loan terms can provide mitigating factors to offset maturity risk as well, such as borrower reimbursement of servicing expenses, meaningful capital or operating reserves, and cash trap features.”