The Fundamentals Behind CRE - Part 1

Continuing the trend of disclosing the dirty laundry in Commercial Real Estate, I am presenting some raw data which the general readership should be made aware of before determining how fair (or not) any PIPP, TALF or other plan is to various beneficiaries.

Here is the summary:

In simple terms, the CRE fundamentals in Q1 are dramatically weaker across most markets and most property segments:

• Price declines of 35-45% (or more) expected, exceeding those of early 1990s
• Rent declines and vacancy rates may approach those of the early 1990s
• Current downturn is demand shock induced versus over-supply induced downturn of early 1990s

The total delinquency rate is likely to exceed 3.5% by year end and 6% by 2010, and the biggest threat facing CMBS is maturity default risk: a large percentage of CMBS loans made in 2005-2008 will not qualify for refinancing without substantial equity injections due to:

• Much tighter underwriting standards
• Massive price declines
• Declining cash flows

Enter TALF, with its inclusion of CMBS as applicable securities: government programs are critical to avoid hundreds of billions of dollars of distressed CRE hitting the market and perpetuating a vicious downward spiral in CRE prices which would exacerbate the damage to bank and insurance company portfolios, and impact other financial institutions.

The facts:

Aggregate delinquency rates are rising sharply, with 30- and 60-day delinquency rates up 300-400% in the past 6 months, and as noted earlier, aggregate delinquencies are expected to hit 6% by 2010.


Monthly total delinquency rates (TDR) are increasing at record pace: prior to September 2008, monthly increases in TDR were in the 0-3 bps range, and in September and October have accelerated to 10 bps. Since October, TDR have accelerated sharply to the 20-25 bps range, an unprecedented pace of deterioration.



As we pointed out yesterday, the deterioration is spilling over into seasoned vintages: all vintages are now demonstrating significant deterioration, however 2006, '07 and '08 vintages are by far the worst performers.



What is the impact by sector?

Hotel loan deterioration is in full take off mode, and expectations are that this will be one of the worst hit sectors during the downturn. As most independent hospitality firms are predicting 10-20% declines in NOI, the result would be TDR worse than the 2001-2003 downturn when cum default rates hit 25%.



The deterioration in the industrial sector is moderate by accelerating: declining production and the collapse in international trade (Long Beach harbor seeing cargo traffic down ~ 30%) implies trouble for industrial space demand.



The deterioration in Multifamily is by far the worst, with the current delinquency rate of 3.53% surpassing the previous 2.35% peak in October 2005.



Of particular note is the accelerating deterioration in recent CMBS vintages



Curiously, the Office deterioration to date is the least pronounced by likely the space where a lot of the pain will be concentrated shortly: it is likely that the recent 85 bps TDR will soon skyrocket.



Lastly, the degree of deterioration in retail is extraordinary. The Retail TDR of 1.66% has surpassed the previous peak in September 2002 and not likely to slow down any time soon. Curiously, the delinquency increases are not driven by single-tenant retail.



The Maturity Risk

As ZH pointed out, chronological series are performing sequentially worse, however, CMBX 4 is underperforming both CMBX 3 and 5.



In the Term market, floating-rate Loans are also beginning to deteriorate. While low LIBOR is a natural hedge, the second LIBOR increase picks up, the term market is poised for the double whammy of constrained lending and higher interest costs.



Additionally, loss severity rates also appear to be rising, although still nowhere near previous peaks of 2002 and 2004, implying there is much more room for deterioration.




As pointed out maturity and refinancing risk is by far the highest threat to the CRE market. Key considerations in looking at maturity risk are: amount and timing of scheduled loan maturities, the current situation in maturity defaults and extensions, the quantifiation of default and extension risk, and whether the end result will be widespread maturity extensions or mass foreclosures and liquidations. The two main sources of maturity default risk are:

Risks that loans will not qualify to refinance due to:

• tighter underwriting standards
• massive price declines
• weakening cash flows
• a 2010-2012 time frame

The complete disruption of of capital markets, even for refi qualified loans:

• CMBS market
• Banks/thrifts
• Life insurance companies
• Pension funds
• 2009 onward time frame

The 09/10 absolute maturities are moderate ($15 billion in 2009 and $30 billion in 2010) but rising precipitously afterward, mostly in 2011 and 2012 ( a high concentration of risky 5 year Interest Only loans from 2005-2007).



Intuitively, declining property prices pose a significant refi threat to loans over the next decade. Absent significant equity checks, and forgiving lenders, the carnage will be widespread. CRE prices peaked in October 2007 after appreciating 30% from 2005 and 90% from 2001! In the meantime Moody's CPPI is down 16.4% from its peak, implying there is much more room for price declines over the next several years.



As these indicators are lagging, it is interesting to see where hypothetical market tests would come out to generate comparable ROE as those seen during the 2007 bubble... And the results are scary: prices need to drop by 45% for comparable returns, assuming an 8.6% cap rate (35% assuming 7.4%) cap rates.



The continuing property price declines are at the heart of the problem: price declines that have already taken place pose significant problems for 2006 and 2007 loans that mature during 2011 and 2012, while inevitable further price declines will create significant problems for earlier vintages.



Cap rates will determine how far prices will fall (and also by implication how soon the death knell for REITs sounds). Cap rates increases to 7% imply a 14% price decline, 8% imply 25% price declines, 9% imply 33% decline and a 10% cap rate is equivalent to a 40% property price decline.



To be continued.

Thanks to TREPP, Intex, Deutsche Bank and others for primary data. Sphere: Related Content

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The "Real" Facts Behind Commercial Real Estate

Unlike the administration, which deals in hope and promises, Zero Hedge believes that facts and empirical evidence tend to have a more justifiable reflection in securities prices. As such, I present a snapshot of the factual deterioration across the entire securitized CRE landscape, and the sad conclusion that with each passing day the inherent cash generating capability of these "assets" is becoming worse and worse. I hope to make this into a recurring piece every week.

Furthermore, the horrendous remittance numbers in CMBX 4 and 3 are starting to spread to old vintages, which is probably the most troubling trend. Also note the dramatic shifts in loss-given-default (LGD) between estimated and actual realized defaults: the jump from 30% LGD to 80% effective loss would demolish any BS book marks if this pattern becomes prevalent from most properties.

Better get that PPIP up and running soon before people dig into the cash flow fundamentals and realize what a true scam the plan really is, and go Poject Mayhem on the HQ of PIMROCK for being a complicit aider-and-abettor to what ZH affectionately calls the scam of the millennium.

CMBX.1 Update

The overall non-performing rate for CMBX.1 rose 11bp, to 1.21%. This does not include loans that were transferred to special servicing. Notable loans include:

• GMACC 06-C1: 35 properties all tenanted by Mervyn’s, which filed for bankruptcy in July, 2008, formed the collateral for the $106.3mn DDR/Macquarie Mervyn’s Portfolio loan (6.37% of deal, SS-Cur). This is one of the three A-notes making up the $258.5mn whole loan. Loss given default is estimated to be 50%.

• GECMC 05-C4: As mentioned above, the $106.3mn DDR/Macquarie Mervyn’s Portfolio loan (4.54% of deal, SS-Cur) makes up one of the other A-notes in the whole loan mentioned and given default; the loss estimate is 50%.

• CD 05-CD1: The $58.0mn Union Square Apartments (1.53% of deal, 30 days), backed by a 542-unit multifamily property in Palm Beach Gardens, Florida, became 30 days delinquent this month. The average value assigned is $100k per unit and 24 months of advancing to arrive at 30% expected loss given default.

• BACM 05-5: The $28.1 Livingston Shopping Center loan (1.46% of deal, current) cured from 30 days delinquency. This is despite dark spaces totalling 61% of NRA due to the Linens ‘N Things and Circuit City liquidations.

CMBX.2 Update

The average non-performing rate of CMBX.2 continued its upward trend with a 25bp increase, to 2.17%. Compared with the other large loans that went delinquent or transferred to special servicing this month, the delinquent loans in this series tend to be relatively smaller.

• BACM 06-5: The average non-performing rate for this deal worsened 268bp this month, due mainly to four DBSI-related loans and a hotel-backed loan. DBSI Inc declared bankruptcy and is the subject of a class action lawsuit from TIC investor. The four loans in question totaled $36.4mn (1.64% of deal, 30 days); all became 30 days delinquent this month. The other delinquent loan is the $23.8mn Crowne Plaza – Cherry Hill loan (1.07% of deal, 30 days) secured by a full service hotel in Cherry Hill, New Jersey.

• MLMT 06-C2: The $20.7mn The Shops of Fairlawn loan (1.54% of deal, 30 days) backed by a retail property in Fairlawn, Ohio, entered 30 days delinquency this month. Last reported DSCR (at year-end 2008) came in at 0.85x. The property also has 38% of space up for lease renewal this month.

CMBX.3 Update

A large number of loans in CMBX.3 were transferred to special servicing or are delinquent. The average non-performing rate increased 38bp, to 2.20%. Of note are the following:

• BACM 07-1: The largest loan to be transferred to special servicing this month is the $220.0mn Solana loan (7.09% of deal, SS-Cur) backed by a mixed use property in Westlake, Texas. This is an A-note of a $395.0mn whole loan. The other pieces are another A-note for $140.0mn, securitized in JPMCC 07-LDPX, and a $35.0mn mezzanine note. The reason for the transfer is an imminent default due to cash flow problems. The estimated loss given default is 40%, based on a stressed cap rate of 9.5%.

• CSMC 07-C1: The Mansions Portfolio loan (4.77% of deal, SS-Cur) is a $160.0mn loan secured by a portfolio of four multifamily properties in Austin and Round Rock, Texas. There is also a $20.3mn mezzanine debt in place. The performance of the two properties in Austin had deteriorated drastically, with DSCR dropping to 0.76x and 0.45x, respectively, last reported in March 2008. The loss expectation of the two Austin properties is about 50%, while the other two performing properties have loss expectations of about 10%.

• MSC 07-T25: The $59.7mn Village Square loan (3.89% of deal, 60 days) is backed by a 237k sf retail property in Las Vegas, Nevada. The borrower is GGP, a regional mall REIT that is struggling under significant debt maturities. The last reported financials in July 2008 came in at 1.0x for DSCR. The former housing bubble state of Nevada had seen an associated weakness in the retail sector, and vacant spaces were either not leased or leased at approximately 30% below the average rate as at issuance. The estimated loss given default of this loan is 40%.

• JPMCC 07-LDPX: As mentioned above, the second A-note of the Solana whole loan (2.63% of deal, SS-Cur), for $140mn, is securitized in this deal. Also of note is the $47.0mn Lembi Multifamily Portfolio loan (0.88% of deal, 30 days) backed by eight multifamily properties in San Francisco, California, which is in 30 days delinquent status. There is an associated mezzanine-note for $10mn. The servicer reported that the borrower failed to replenish debt service reserve as required. The most recent DSCR reported in September 2008 is 1.18x. A loss of 30% is estimated given default.

• CD 07-CD4: The $117.0mn Loews Lake Las Vegas loan (1.78% of deal, SS-Cur) was transferred to special servicer due to imminent default. The loan is secured by a full service hotel in Henderson, Nevada. The most recent DSCR, reported in June, 2008, came in at 0.37x. 40% loss is expected given default based on a 10% cap rate.

• MLCFC 06-4: The performance of this deal continues to worsen this month with a 153bp increase in the 30+ day delinquent rate, due primarily to two office loans, the $50.3mn The Parkdales loan (1.12% of deal, 60 days) and the $18.4mn Pentagon Park loan (0.41% of deal, 60 days) both backed by office buildings in Minnesota. No servicer’s comments were provided for either loan. The most recent DSCR, reported in September 2008, came in at 1.32x and 0.96x, respectively.

CMBX.4 Update

CMBX.4 is the worst series in terms of the average non-performing rate, increasing 42bp, to 2.19%. Notable loans include:

• JPMCC 07-LD11: Similar to the Lembi Multifamily Portfolio loan in JPMCC 07-LDPX, the $90.0mn Lembi Portfolio loan (1.67% of deal, 30 days) is backed by 16 properties in San Francisco, California. This is also part of a whole loan that includes a $25.0mn B-note and a $17.4mn mezzanine-note. The most recent reported DSCR in December 2008 is 1.24x. The servicer also reports a failure of borrower to replenish debt service reserve as required. A loss of 25% is estimated given default.
  

• MLCFC 07-7: The $45.0mn Mervyn’s Corporate Headquarters loan (1.63% of deal, 30 day) backed by a single tenant office building in Hayward, California, entered 30 day delinquency. Mervyn’s filed for bankruptcy protection in July, 2008. Appraisal for the property came in at $17.6mn and factoring in advancing would result in an expected loss of 80%, versus original estimates of 30%.

• JPMCC 07-CB19: The $36.5mn Bronx Apartment Portfolio loan (1.12% of deal, 30 days) is yet another pro forma multifamily portfolio loan that is deteriorating. The collateral is two properties comprising 490 multifamily units in the Bronx, New York. A 35% loss is expected given default.

CMBX.5 update

CMBX.5’s average non-performing rate worsened 21bp, to 2.44%. Of note:

• JPMCC 08-C2: The $25.0mn Regency Portfolio loan (2.15% of deal, 30 days) is the A-note of the $26.6mn whole loan (with a $1.6mn B-note) backed by a portfolio of 20 properties of various types in Iowa and Nebraska. The most recent DSCR reported in September 2008 came in at 0.66x.

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Commercial Real Estate Marking: CMBS Relative Value

At first opportunity (but not for a few days) I will write an extended post on the cash flow dynamics of both CRE whole loans and CMBS. There seems to be too much confusion on the topic, which is at the heart of the "is the price fair/is it not fair" argument for the toxic asset bid/offer disconnect in the PPIP. Below is a good chart I tracked down which shows the most recent prices on sub-AAA CMBX tranches, and how this flows through in terms of spreads, loss rates, loss timings, average deal losses and a market-to-base case (flat loss assumption) ratio. Not surprisingly the MTB deal loss ratios become more pronounced the higher up in the pool one goes, with the AJ likely having the best or worst bang for the buck (AAA is excluded from this analysis), depending on one's optimism/pessimism. Curiously, based on market implied statistics, the 2006-2008 vintages rated A and below have an average 100% loss within 3 years!Some other concepts to consider: the dominant role of GSEs and commercial banks in CMBS issuance, the lagging DSCR impact on longer-dated lease term properties (office and retail doing better than multi-sector for now: 2006 vintage average leases begin rolling this summer, should make for a curious move in DSCR), the transition of numerous IOs to amortizing, the CMBX-cash basis (negative blow out in December thru February) an substantial convergence recently implying securities liquidity considerations are mitigating (together with the ability to blame the market for mark aberrations), and lastly unemployment itself: CMBS delinquencies peak 1 year after unemployment bottom inflection point. 

thanks to Lehman for raw data

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The True State Of The CMBS Market, And Why Billions In New Writedowns Are Coming

In response for requests for information on where the capital markets objectively evaluate commercial mortgage backed securities, and also to demonstrate the recent knee jerk reaction of how CMBX spreads ripped wider once it became clear older vintage, sub-AAA would not be eligible for TALF 1.0 participation, I am presenting the recent trading levels of CMBX 1 through CMBX 5, segregated by tranching (rule of thumb: the higher the chart line, the lower the underlying value, the more MTM pain for sellers of the CMBX tranche i.e. banks). The mid-to-late February explosion was a result of the market realizing these securities would not be eligible for taxpayer support in the TALF 1.0 version, and thus indicative of the true, and very sad, state of the commercial mortgage backed real estate market (some good intro material on CMBX here).

The annihilation in CMBX (for lack of a better word), explains the recent urgency behind the Treasury's moves to provide an iteration of TALF that will return some sense of normalcy to the CRE securitization market. The majority of CMBX tranches trade at levels which imply vast losses at low recovery values on the underlying loans.

As there are hundreds of billions in underlying notional behind the various 1 thru 5 vintages, the mark to market pain experienced by major banks and financial institutions (who would sell CMBX risk to willing purchasers) in the recent widening sprint is likely to generate another round of massive write-downs at all TARP recipients.

Also, for an indication of just how bad bank writedowns will be this quarter, a good proxy is the average levels of the various CMBX indices at Dec 31 and where they are trending now. If the current price levels persists, it will be a bloodbath.

CMBX 1



CMBX 2



CMBX 3



CMBX 4



CMBX 5



hat tip to JP Morgan for chart data. Sphere: Related Content

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