(Bloomberg) -- More than $7 billion of loans tied to office properties that were bundled into bonds are coming due over the next 12 months, and many of them won’t be able to refinance.
The problem loans mature right around when tenants in the offices are due to renew -- or end -- their leases. That may unsettle investors in commercial mortgage-backed securities, analysts at Moody’s Analytics warned this week. The risk is especially acute for buildings in regions where there are still high office vacancy rates and continuing rent declines.
“The office market is still digesting how preferences for work from home, or WFH, may reduce office demand and lease renewal sizes,” Moody’s Analytics analysts Darrell Wheeler, David Salz, and Thomas LaSalvia wrote in a Wednesday blog post. “With this developing WFH factor, lenders and investors have been using more conservative assumptions in underwriting office loans.”
To reflect this more stringent due diligence, Moody’s compiled a list of office CMBS loans that expire over the next year that are linked to buildings that have more than 20% of their tenants with leases expiring in the next 36 months, or a cash flow debt yield of under 8%. That yield is a metric that gives investors a sense of cash flow relative to the loan amount.
At least eight properties with exposure in CMBS deals have both an upcoming lease expiry from at least one tenant, as well as a low debt yield. Meanwhile, another 17 office properties each have more than 20% of their leases rolling over during the next three years, the Moody’s data show.
Read more: CMBS Market Faces Crunch as $40 Billion of Mall Debt Comes Due
For example, a $201.5 million loan tied to 360 Park Avenue South office tower in Manhattan -- included in a 2007 CMBS deal -- has 100% of its space expiring in December, according to the Moody’s report. “An internet search reveals that space has been actively marketed for some time. In that case, we expect the loan may not be able to refinance,” the analysts said.
The building is in a state of flux. Boston Properties Inc. agreed in July to buy it from current owner Enterprise Asset Management. The new owner plans extensive upgrades to “transform it into a premier modern building that will attract Class A clients,” according to a press release. Boston Properties did not immediately return a message seeking comment.
There’s uncertainty for many properties. A building near Union Station in Washington DC and another in downtown Los Angeles -- both in the same 2012 CMBS transaction -- have 22% and 56% of tenants rolling over in the next few years, respectively.
“The borrowers should be able to refinance, potentially using transitional floating-rate financing if the borrowers lock in some of the tenants that are scheduled to expire,” the analysts said, but that remains to be seen.
Proceed With Caution
Despite shrinking demand for office space, lower rents and uncertainty about how much telecommuting will occur post-pandemic, investors have clamored for securitized bonds that offer a little more yield than other asset-backed debt and corporate paper. There have been a string of single-asset single-borrower (SASB) commercial mortgage bonds sold this year tied to the financing of urban office buildings.
Investors are still willing to put money into properties they see as high quality, known as Class A properties.
Read more: Massive NYC Office-Tower CMBS Hits Market
But when it comes to less highly rated office buildings, underwriting will likely use Covid-era cash flow metrics from 2020, which may inhibit the size of a new loan, or even dissuade lenders from making the loan at all, Moody’s Analytics’ Wheeler said in an interview.
The refinancing environment is improving, and so are 2021 cash flows, but looking at maturities during the past year, only 35% of loans, representing 65% of loan balances, paid off on time.
“As we move into 2022, hopefully the 2021 cash flow will improve, creating better debt yields,” Wheeler added. Debt yields need to be higher to leave room for amortization or a margin of error in calculating cash flow, or for unexpected expenses, Wheeler said.
Investors should analyze upcoming loan maturities with an eye to lease maturities, as uncertainty will likely persist into next year, the analysts cautioned.
Relative Value: ABS
- Bank of America analysts believe that spreads in the ABS market are likely to continue to leak wider over the near term, according to the firm’s latest securitization weekly overview report
- Spreads have remained near cycle lows across most AAA rated securitized products sectors. BofA noted that may be due for a change. While spreads for credit card ABS were 1-2bp tighter last week, a number of AAA rated ABS sectors experienced modest widening including the rate recovery bond, equipment, floorplan, fleet lease, retail auto lease, and device payment plan ABS sectors
- Away from AAA rated sectors, spreads for subordinated tranches of auto loan ABS were up to 15bp wider last week, analysts said
“If you’re going to invest assuming the Fed will always be there for you, and next time they don’t, that’s a moral hazard,” Dan Zwirn, chief executive officer of Arena Investors, said in a recent interview, referring to buyers of CLO tranches, who he believes are at risk in the long term
ABS deals in the queue include American Credit Acceptance (subprime auto), Marlette Funding (consumer loan ABS), Stonepeak (aviation ABS), and Sunnova (solar loan)
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