The year 2020 started off strong followed by a roller coaster of economic events in Q1 and Q2. A pandemic left offices, hotels, malls and streets vacant as America stayed home. Unemployment reached unprecedented highs. The economy slowed but didn’t stop with the aid of government stimulus. The stock market experienced volatility, though generally showed buoyancy. Overall, companies have experienced unforeseen stress to their bottom line putting pressure on credit metrics and affecting the lending market.
Lenders, both banks and non-banks, generally put a halt on writing loans to reevaluate their strategy and shift into loan surveillance. Some borrowers were granted forbearance or other temporary modifications to their loans, typically for a period of three months. Now July, many borrowers are reaching the end of that period. More defaults are expected for borrowers that are still experiencing stress. Similarly, some loans that may have been in a payment grace period are starting to fall out of grace as they haven’t been able to cure their loans. Many of these distressed loans will be sold by the end of 2020 with some NPL’s coming to market now.
Tracking CRE mortgage distress, public data from CMBS gives us a window into loan defaults. The graph below shows the upward trajectory of June delinquency data reported by Trepp.
As of Q1 2020, the outstanding CMBS universe was $516 billion and the outstanding commercial mortgage universe was $3.72 trillion as reported by the Mortgage Bankers Association. Assuming the CMBS default rate is consistent with the outstanding commercial mortgage universe, there is $384 billion of delinquent commercial mortgage loans.
Breaking down the June 2020 delinquency rate, the table below details the rate by property type. Hotel and retail loans have shown the greatest distress so far with expectations of increased delinquency for office loans.
Hotels have the highest delinquency rate due to the lockdown on travel. Having the shortest lease term being priced daily, hotels revenue effects are immediate. STR expects occupancy to return to the long term average by 2023 with hotels discounting price for market share. STR’s 2020 hotel demand projections are -35.6%. Continued defaults in hotel mortgages are expected as hotels struggle to survive.
The retail sector has been hard hit due to forced store closures and changes in retail behavior. Sales have increased for online retail, supermarkets, and drugstores during the shut down. However, that isn’t the norm for retail tenants. According to Datex Property Solutions, 68% of national chain retailers paid their June rent. More retail distress is expected with continued announcements of bankruptcies which will negatively impact mortgages on retail properties.
Multifamily has been affected as well due to job losses and consumer financial strain. According to the National Housing Council, 77% of households made a partial or full rent payment. Delinquencies remain relatively low by comparison.
The future of the office sector is in question with the effectiveness of work from home and the concerns of social distancing while at work. Some argue that companies will remain remote, while others argue the loss of culture and productivity require companies work out of the office. Similarly, tenant footprints are argued to decrease with fewer people in the office or increase giving more space per employee. There is stress on the sector, and despite the longer lease terms some borrowers will face tenant vacancies, renegotiated lease terms and increased expenses due to the pandemic. More distress is expected to be seen in office loans and defaults.
The industrial sector has been less affected by the pandemic and is expected to remain stable. The changes in the retail dynamic and online sectors have helped lessoned the stress of industrial tenants. A stable level of default is expected for industrial loans.
All in all, with approximately $400 billion of defaulted CRE loan outstanding and continued stress in the commercial mortgage sector, the coming months expect to bring increased loan defaults and increased opportunities for distressed debt buyers. Lending and capital markets are showing signs of opening. Workout specialists are busy and NPL’s are coming to market.