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Are Offices Next for CMBS Delinquencies?

SitusAMC’s Head of Special Servicing discusses the improving pipeline for distressed CMBS loans and trouble spots that could still be on the horizon.

Despite hitting a new 14-year high for CMBS issuance in 2021, special servicers are still working to resolve elevated levels of loan delinquencies.

Industry data points to steadily improving CMBS loan delinquencies. Delinquencies that peaked at 10.3 percent in June 2020 fell to 4.18 percent at the end of January. The hardest hit sectors, lodging and retail, both have notched significant improvement with 30-day delinquencies now at 8.37 percent and 7.96 percent respectively, according to Trepp.

WMRE recently spoke with SitusAMC Head of Special Servicing Curt Spaugh to hear his views on what’s ahead for CMBS delinquencies. The firm's special servicing division has expertise with complex capital structures, bankruptcy, and REO management across all property types and geographies. In addition, the company recently announced that it secured 107 special servicing assignments in 2021 that total more than $65 billion in unpaid principal balance.

This interview has been edited for style, length and clarity.

WMRE: SitusAMC secured a substantial volume of new special servicing assignments in 2021. Just to clarify, are those assignments for loans in distress, or just new issuance?

Curt-Spaugh.jpgCurt Spaugh: That volume refers to new issuance backed by commercial real estate loans. If anything goes bankrupt, or is delinquent or is at risk of an imminent default with any of these new loans, then we would be handling that as special servicers. However, these are newly originated loans in 2021, and none of those loans are distressed at this point.

WMRE: How does that $65 billion compare to new assignments your firm received in 2020?

Curt Spaugh: It was a big increase for us. In 2020 we had to ramp-up very quickly due to COVID. There was a lot of distressed loans that came to the door in March, April and May of 2020. We hired some really good people; we have a really good team that works well with our clients; we’re very responsive; and I think the industry has taken note of that.

WMRE: I would assume part of that growth is due to CMBS issuance that also hit a new post-Great Financial Crisis high?

Curt Spaugh: Yes, it is a function of issuance being up in general. No doubt about that. Another thing that drives our numbers on the dollar volume is that we have become a bit of a SASB specialist. A lot of the larger SASB deals that have been coming our way might be a $200 million to $500 million deal or even $1 billion plus.

WMRE: Industry data shows that CMBS delinquency rates continue to decline. What’s your view on where CMBS delinquencies are at overall and where they’re headed?

Curt Spaugh: We have seen gradual improvement in delinquencies, especially in the lodging sector and resort lodging in particular. Urban lodging that is next to a convention center is continuing to struggle. Retail is struggling too, but it’s getting better. 

WMRE: Where do you see the biggest hot spots for problem loans right now?

Curt Spaugh: The property type that we’re keeping an eye on is urban office. The work-from-home experiment seems to have worked well for employers and employees. That is yet to be reflected in commercial real estate delinquencies, because all of these office buildings have long-term leases. So, you won’t know the effect from work-from home until leases expire down the road.

I’m expecting that some companies won’t renew their office leases, and some companies will renew for less space and go to a hybrid model. That’s where it’s going to be interesting to see what happens in the office space. I think there’s going to be a flight to quality. The B type office is really going to struggle as tenants have the ability to upgrade to an A space for the same rate they were paying for their B space. We’re seeing that in New York with a flight to the newer properties that have gone up there. So, that’s where trouble is on the horizon.

WMRE: Given the long-term leases that are propping up the office sector, when do you think we might see some of that distress rolling in?

Curt Spaugh: Most likely it’s going to come up in the next year or two or three. A lot of these larger SASB loans are not done with a typical 10-year loan term. A lot of them are three-year loans with three-year extensions. Some of those loans were made in 2017, 2018 and 2019 at the top of the market. We might see some of those loans default at maturity, where maybe they were able to pay, but they can’t get take-out financing. It’s going to be difficult to underwrite take-out financing, because you don’t know what’s going to happen to leases that are expiring in the next year or two at the time of that refinancing. Who knows what that is going to look like, but I see this becoming a bigger problem two and three years out.

WMRE: Looking at the distress that is currently in the market or has recently been cured, what kind of solutions are most common these days?

Curt Spaugh: We may be different from other special servicers because we are heavy in SASB, but we have either brought loans current by using reserves and doing, not a major restructure, but what I would call a short-term modification that has involved pulling from reserves or giving a short debt service break.

In some cases, we have ended up foreclosing. We’ve all been around enough to know not to kick the can too much, and a lot of borrowers feel the same way. If they don’t see an exit, they’re ready to throw in the keys. There haven’t been a lot of times where it wasn’t black or white. Everybody knows when a property is going to struggle, and no one wants to throw additional capital at it. Of course, we would always require some additional skin in the game for any type of major restructure. So, we have had either minor modifications or foreclosures and that’s been about it.

WMRE: Do you have any data or perhaps anecdotal insight on how much distress ended up in foreclosure as REO property?

Curt Spaugh: For us, overall it was a small percentage that went REO, and significantly less compared to the Great Financial Crisis days. Part of that reason is that there was a little bit more clarity on the future for people, especially in the lodging industry. People felt that it was a COVID problem and they would be ok if they could get over that hump. In the Great Financial Crisis, no one could see when we were coming out of that, and people gave up a little easier on properties at that time.

WMRE: Do you think there is much in the way of REO ahead?

Curt Spaugh: We don’t see the great liquidations that we saw in 2008, 2009 and 2010. People are pretty comfortable that we’re over COVID and they want to travel and there is that pent-up demand for getting out. The issue is really what did COVID cause to change in our world, and again I go back to the office product and the fact that people can work from home and be effective and perhaps save their employer significant leasing costs by doing so. Urban retail in markets such as San Francisco or Chicago are likely to struggle, and there will be some areas of urban hospitality that are not driven by tourism that will suffer as well. For us, cases of REO are rare, because we do have a large portfolio of SASB, a large CLO portfolio and a large single-family rental portfolio.

WMRE: The pandemic created unprecedented circumstances. Has it produced any longer term structural changes to CMBS or how special servicing is handled?

Curt Spaugh: I don’t know that it has changed all that much. A lot of things changed after the Great Financial Crisis, and I think we’ve seen the results from that. Underwriting on loans has been much better this time around, which is part of the reason why we haven’t seen as many liquidations and foreclosures. CMBS corrected itself after the Great Financial Crisis, and this time when we had COVID hit us, it seemed as though things were a lot smoother for the industry in general.

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