Commercial Real Estate Debt
In the CMBS market, 2021 started with a “January effect” on steroids. In addition to the factors that typically push CMBS spreads tighter to start the year, such as the need to invest newly allocated capital into the market, we believe overall market dynamics in the first quarter were supplemented by a few additional considerations this year. One factor is that the recovery in CMBS has tended to lag other product types, so the space offered some yield pickup. Additionally, with the COVID-19 vaccination rollout gaining momentum, property valuation uncertainty has been mitigated to some degree. Finally, given a limited amount of maturities in 2021, issuance volumes are expected to remain light by historical standards.
The positive momentum continued into February and early March, albeit at a slower pace. By the end of the quarter, a bit of softness started to be seen in the market, with several new issue transactions needing to widen spreads from initial guidance in order to clear; however, this felt more like a pause than an actual reversal in sentiment.
The overall CMBS delinquency rate continues to trend lower, with March becoming the ninth consecutive month of improved loan performance. According to Trepp, the overall delinquency rate declined from 7.81% to 6.58% during the quarter. Not surprisingly, the hardest-hit sectors in 2020 led the recovery this year, with the delinquency rate in the hotel sector dropping from 19.80% to 15.95% and retail declining from 12.94% to 10.89%. Office delinquency rates held steady at just over 2.00%, while the industrial sector continued to shine, ending the quarter at less than 1.00%. Loans secured by multifamily properties experienced a 39-basis point, or 0.39%, increase in delinquency—rising from 2.75% to 3.14%. We believe this is a trend that warrants ongoing focus, particularly as eviction moratoriums eventually sunset.
In our opinion, the greatest area of uncertainly in the commercial real estate markets relates to the office sector and the long-term impacts of more remote or work-from-home options for employees. These trends are going to play out over years, and the dispersion of potential outcomes is huge. Fitch Ratings recently published a research report that projected 45-54% declines in office property values based on what they referred to as moderate and severe work-from-home scenarios. We believe this headline-grabbing result is somewhat misleading because it combines cash flow declines with a significant increase in capitalization rates. We think the aforementioned severe downside scenario is highly unlikely, but these will be trends to watch closely for years to come. Not all markets and properties will be impacted to the same degree, which is why we believe taking a loan-by-loan approach to analyzing each transaction is key.
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Total quarterly issuance returned to pre-pandemic levels.
Single-Asset/Single-Borrower (SA/SB) delinquency rates are noticeably lower than conduit delinquency rates across property types.
Special servicing rates have been gradually declining over the past six months.
Interest shortfalls in conduit CMBS are concentrated in the non-rated portion of the capital structure.