Commercial Real Estate Debt

After the first quarter’s dramatic sell-off and last quarter’s rapid price recovery, the third quarter was a steady move towards more normalized market conditions. At the top of the capital structure, new issue AAA CMBS spreads are at pre-COVID-19 levels, while spreads remain wide to February 2020 benchmark levels further down the capital structure. Pricing in the secondary market has followed a similar path but with considerably more dispersion.

During the third quarter, seven private label conduit deals totaling $5.1 billion and 11 Single-Asset/Single-Borrower deals totaling $7.6 priced in the U.S., resulting in year-to-date volume of $42.7 billion—a 27% decline versus the first nine months of 2019. We are expecting a number of deals to price early in the fourth quarter followed by a slowdown in issuance into year-end.

Looking closer at fundamentals, the overall market recovery has been slower than optimists had hoped but quicker than pessimists had feared and should be viewed through a cautious lens, as even something as seemingly straightforward as a delinquency rate needs deeper consideration. During the third quarter, the percentage of CMBS loans categorized as 30 days or more delinquent declined from 10.32% to 8.92%. Over that same period, the percentage of loans transferred to the special servicer showed a nearly opposite trend, growing from 8.28% to 10.48%. The reason for this seeming anomaly is that borrowers that reach a forbearance agreement are typically reclassified as current even if the borrower has been granted temporary interest payment relief or is allowed to tap excess reserves to remain current on their mortgage payments. The numbers are not perfect, but we believe the specially serviced rate is a more accurate reflection of loan distress. As one would expect, loans secured by hotel properties are showing the most distress, with 26.0% of those loans specially serviced at the end of September, followed by retail, with 18.3% of all CMBS loans secured by retail properties in special servicing at the end of the quarter.

Going forward, we are closely monitoring borrowers that have been given a temporary forbearance and are now seeking a longer-term modification, reflecting the fact that—for certain assets—the recovery in performance is taking longer than expected.

With transaction volumes still at a faction of historical levels, property appraisers are forced to do their jobs with few data points. We have seen a handful of recent appraisals on distressed properties and—not surprisingly—there is a very wide dispersion, with certain properties appraised at dramatically lower values, while others actually increased over earlier assessments. On a weighted average basis, newly appraised loans are down 23%, and we expect appraisals on troubled assets to trend lower for an extended period of time.

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Q3 2020 quarterly private label issuance was flat compared to last quarter’s total.

While delinquency rates have come down from their near-historic peaks, the percentage of distressed CMBS loans remains elevated.

Post-COVID-19, new issue conduit CMBS deals have significantly less retail and hotel exposure.

Over $400 billion of CRE debt is scheduled to mature in each of the next several years.

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