Mortgage loan default rates, which were a leading symptom in the commercial real estate sector during the pandemic, continue to improve. Worryingly, however, the high defaults in the lodging and retail sectors are expected to continue as troubled loans slowly work towards solutions, with some defaults to be expected.
All property types saw a slight improvement in defaults, with the overall rate improving 30 basis points to 95.5 percent in July, according to the MBA's CREF Loan Performance Survey. Real estate loans and retail real estate loans continue to face the highest stresses. Accommodation business defaults improved from 17.6 percent in June to 16.5 percent in July, while retail loan defaults decreased from 10.0 percent to 9.0 percent. CMBS's loan defaults are also 8.2 percent higher than other sources of capital.
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There are still many "what-if" requirements that will affect the extent of the plight in commercial real estate. Some believe that the hardship has reached its peak and is gradually easing. Others believe that even more distress could flare up in certain pockets, especially if forbearance and government incentives disappear. The Delta COVID-19 variant is another wildcard that could weigh heavily on economic recovery and block return momentum in the real estate sectors, especially accommodation and even offices, as rising cases push many companies to their plans for return delay in the offices
Despite all of this, the massive emergency wave that some predicted at the start of the pandemic did not materialize. For example, last December, CoStar released data from its predictive modeling that projects 16 different scenarios for the volume of distressed asset sales that could potentially occur over the next five years based on different assumptions. The models ranged from a high of $ 659 billion to a low of $ 134 billion, with an average high of about $ 321 billion. CoStar has since pulled out of these models, in large part because there are so many unique variables in the current marketplace that affect NPL outcome. In addition, some of the downward assumptions made in the models have never proven to be true.
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"There are still a lot of uncertainties to monitor, but my new expectation is that if we can maintain the rate of recovery that we currently have, the volume of bad loans will be reduced dramatically," said Xiaojing Li, Managing Director Risk Analytics at CoStar.
There are a number of factors why the distress is less severe and why the loan processing steps have been more effective. Government incentives and forbearance have played a huge role in containing the hardship. Additionally, real estate generally has lower leverage and the pre-pandemic valuations were solid, putting borrowers in a better position for redevelopment.
One way forward for bad loans
There are several solutions for bad loans. In some cases, a borrower simply needs more time and continued recovery to get the loan back on track. Another option is to bring in new equity and / or restructure the loan. The third way is to liquidate that troubled loan through a discounted payout or foreclosure and a REO or promissory note sale.
Historic stimulus packages along with lender indulgences and moratoriums on litigation have given borrowers more time to find solutions to emergency situations. "We saw that in the past 18 months the majority of lenders chose to postpone decisions just because they could afford to wait," said Patrick Arangio, vice chairman of the national advisory practice for loans and portfolio sales at CBRE.
At the same time, the ample liquidity combined with the persistently low interest rate environment also opens up more options for borrowers. "There is a historically significant amount of capital earmarked for investment by institutions specifically targeting opportunistic investments through loan sales, distressed property sales, recapitalizations, and so on," says Arangio. "In combination with this interest rate environment, this liquidity limits the volume of non-performing products. Therefore, we have seen and continue to see a pronounced imbalance between supply and demand. "
This capital revolves around troubled housing and retail stores in hopes of doing some opportunistic deals. Hotels were very "risk free" during the height of the pandemic, notes Arangio. "We have seen significant inflows of debt and equity over the past three quarters with the express goal of investing in the hospitality industry," he says. "We expected it to happen, but the speed and scale of the return to the sector has been remarkable." The overarching caveat is that there is an escape into quality. The pool of interested bidders for non-performing hotel loans tends to be smaller for full-service hotels that are dependent on group bookings and conference business, as well as for older capital-intensive hotels, those with long-term leases and hotels with unionized employees. "Still, we continue to see very active involvement in opportunistic transactions," he adds.
The retail sector faces very different challenges as the sector has been hit by the pandemic as well as the underlying issues related to increasing competition from e-commerce and changing consumer behavior. The distress that has arisen is focused on high street retail in the major CBDs and regional Class B malls. and C malls may never recover, "said Jack Howard, executive vice president, National Loan & Portfolio sales advisory practice at CBRE. So there will likely be more bad loans for B and C malls, he notes.
Deep discounts are rare
Failures in the lodging and retail sectors could remain elevated for some time to come. It can take up to three years for a property to fully go through foreclosure, REO and possible sale, notes Li. will take longer, "she says. The extra time, whether through forbearance or patient lenders, could benefit borrowers as it gives borrowers more time to recover, she adds.
CoStar conducted a historical comparison of non-performing loans following the 2009/10 Great Financial Crisis and the 2020 COVID-19 downturn. The results show that 35 percent of CMBS loans that were in default 12 months after the financial crisis were either liquidated through banknote sales or REO real estate sales. In the 24th month, the percentage of past due loans that were liquidated rose to 54 percent. The same NPL analysis that took place after the COVID-19 downturn shows very different results. Only 5 percent of the overdue CMBS loans were liquidated by the 12th month. It remains to be seen how much these numbers could rise by month 24. However, the early data shows a dramatically different scenario to date, notes Li. Li expects the percentage of loans liquidated to remain subdued and likely to remain below 10 percent.
In addition, the high discounts that many investors had hoped for in distressed REO and bond sales have not materialized. While there have been anecdotal examples of sharply reduced loan sales, most values have held up fairly well. Limited service hotels are a sector that has recovered very quickly. For example, CBRE recently bid for 95 percent of its outstanding principal to sell a distressed hotel loan with limited service. "So you could argue that some of the distressed products are not trading at distressed prices," says Howard.
The values have largely held up due to simple supply and demand fundamentals. The amount of capital raised for opportunistic investments far outweighs the volume of non-performing assets that have arisen. "We are seeing a record turnout in loan sales that reflects the amount of capital raised and continues to support loan value," added Howard.
source https://seapointrealtors.com/2021/08/09/commercial-real-estate-mortgage-delinquencies-continue-to-decline/
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