Commercial Investment Real Estate Spring 2020 | Page 17

Table 2: Loans with Single Tenant Exposure in CMBS 2.0 Deals # Loan Name Curr. Loan Bal (mm) Bal ($psf ) Loan Maturity Date MSA Largest Tenant Lease Expiry % of Tenant Gross Vacated/ Leased Planning Area to Vacate (GLA) 1 Two Westlake Park $89.23 $198 Houston Oct. 21, 2020 Conoco Philips Nov. 19, 2020 Yes 46% 2 Three Westlake Park $78.89 $188 Houston Feb. 24, 2020 Conoco Philips Feb. 19, 2020 Yes 58% 3 Palazzo Verdi $73.5 $243 Denver July 25, 2020 Newmont Mining Corp Oct. 20, 2020 Yes 72% 4 Scripps Research Building $31.53 $281 San Diego Jan. 23, 2020 The Scripps Research Institute June 19, 2020 Yes 100% 5 Broadcom Building $35.7 $178 Broadcom Corporation May 18, 2020 Yes 0% San Jose, Calif. Jan. 25, 2020 Source: Remittance reports through various trustees and servicers websites loan origination, but they consolidated operations during the economic downturn. • Tenants decided to move to a nearby location with better amenities and lower lease rates. • Most loans had insufficient cash reserves, repre- senting less than 5 percent of loan balance. IMPACT ON BOND VALUATION As shown in Table 1, the One AT&T Center loan locat- ed in St. Louis has a cut-off balance of roughly $107 million and is currently 100 percent vacant after the tenant vacated the property upon lease expiration in September 2017. The borrower has struggled to re- tenant this property despite its downtown location due to its large size (1 million sf ), higher amount of similar available space, and heavy capital expenditure requirements. Using appraisal reduction estimates ($92.4 million) as a proxy for implied losses on this loan as of January 2020, we expect three tranches to realize full principal loss and another to lose almost 8 percent of its principal upon liquidation. If losses stay below $79.8 million, that tranche will not realize any principal loss. On the other hand, losses can be as high as $107 million, implying that this tranche can lose up to 20 percent of its principal balance. The impact of losses stemming from such large loans in the deal could have a meaningful impact on bond valuations depending on the magnitude of loss- es, available credit support, and tranche sizes (i.e., the percent of the deal). CMBS 2.0/3.0: SINGLE-TENANT TAIL RISK CMBS 2.0 and 3.0, CMBS transactions issued after the financial crisis of 2007, have shrunk from $4 or 5 bil- lion to roughly $1 billion, meaning pools have become more concentrated. Exposure to single tenants has grown and requires in-depth analysis for any potential unforeseen issues. Table 2 shows similar trends from sample loans in CMBS 2.0/3.0 deals. In the first three cases, tenants related to the energy sector (Newport Mining Corp and Conoco Philips) continue to struggle as oil prices remain low and tenants vacated at lease expi- ration dates. In the Broadcom example, the tenant departed because of ongoing consolidation in the telecom/technology sector. The early termination CIREMAGAZINE.COM A downturn or consolidation in a particular sector will lead to widespread downsizing in space. In addition, with the growth of coworking tenants, assessing single-tenant risk is not a straightforward exercise. option gave the company the flexibility to vacate be- fore the lease expiration. While none of these loans has been resolved or recorded losses yet, exposure to a large tenant either announcing a departure or al- ready vacating the property is notable. That doesn’t mean all loans will default or will experience higher losses, as strong geographic asset characteristics, in- creased reserves, and other trigger mechanisms such as cash sweep events can mitigate losses. However, office properties located in heavily oversupplied mar- kets or highly dependent on certain industry sectors may be of concern. Anecdotal evidence suggests that a downturn or consolidation in a particular sector will lead to widespread downsizing in space. In addition, with the growth of coworking tenants, assessing single-tenant risk is not a straightforward exercise. Office proper- ties located in major markets — namely New York, Washington, D.C., and San Francisco — tend to re- tenant space at stable or premium rents over time. However, in lower-tier locations where submarket demographics are not favorable, office properties with significant space may not re-tenant at the same speed or frequency. CMBS 2.0 underwriting is relatively conservative when compared to legacy CMBS underwriting from both debt service coverage ratio and loan-to-value perspectives. However, CMBS 2.0 office loans with large tenants haven’t experienced an economic downturn yet, and the macro environment remains supportive for the office market in the U.S. Furthermore, in-depth analysis has become more complex due to ongoing trends, such as shared space/ smaller space per employee along with the volatile nature of predicted cashflows. These features were rather uncommon in CMBS 1.0 deals, but they present unique challenges and valuation opportunities in today’s market. Manish Agarwal Vice president for PricingDirect by JPMorgan Chase Contact him at [email protected]. Pramod Bharadwaj Associate for PricingDirect by JPMorgan Chase Contact him at [email protected]. COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE 15