Thoughts on Rising CMBS Delinquency Rates
Trepp’s June 27 research note on CMBS delinquencies, states that about $2.4 Billion in loans had become delinquent last June pushing the delinquency rate to a peak 5.75% [ +28 bps over May] and contributing to the major increase in Commercial Real Estate loan delinquency rates seen in in five  years; the last time the market had seen such a sharp increase was back March of 2012. It further states, that after hitting post crisis lows in February of 2016, this key indicator has been steadily climbing over the past year as loans underwritten in 2006 and 2007 reached their maturities. In fact, the report indicates that 2/3 of the referenced $2.4 billion, came from loans that reached their balloon date and did not pay off.
Even though the 5.75% delinquency rate is lower than the all-time high of 10.34% reached in July 2012, the level of delinquencies, for newly delinquent loans was at the same level we saw in 2010 and those of us who were in the trenches back then, remember that it was a bad one…
Of special interest to us is the fact not only all major property “Food Groups” saw an increase in delinquencies rates, but the highest increase was manifested in the Multifamily sector, which rose by 110 basis points to 3.92%.
If we consider the high participation of loans that reached their balloon date without pay off, many of them underwritten in the 2007 pre-recession period and add to that, the elevated risk associated with full term interest only loans which are not uncommon in the sector, the tightening in lending regulations for CMBS lenders who are now required to hold 5% of each new loan (or assign it to a B piece) and the higher interest rate environment It is, no wonder that the Multifamily sector has demonstrated the above increase in delinquency rates.
So, what does this mean in practical terms for investors in the sector? does it mean, that we should expect blood in the streets and a market flooded with properties that are over leveraged and need to be sold at deep discounts to pay off their looming maturities?
No, we don’t think anyone is seriously considering this scenario.
Does that mean that the Multifamily sector is losing its glory as the best performing sector in Commercial Real Estate?
Highly unlikely! We may see some more supply coming into the market and some price adjustments in certain markets but the demographic trends, especially in the top 50 markets in the country are such that this increase in CMBS delinquencies and any subsequent sales of properties under a varying degree of distress may be viewed more as a healthy correction and not as a major sell off.
Additionally, the availability of agency debt, especially in the top markets, will serve as a strong refinance alternative to delinquent and/or defaulting CMBS loans.
So then, where will the opportunities lie for smart investors?
In our opinion, the great opportunities lie in two fronts: [a] in the A- to B- Multifamily type properties located in the secondary markets within top 50 markets in the US and [b] in properties that are up for sale but have been aggressively leveraged in the last 5 years, both in terms of LTVs, long period Interest Only loans and floating rates (considering that 30-day LIBOR was at 1.22% on June 27th vs. 0.47% on June 27th, 2016 – that’s an increase of 2.6X to an interest only floating rate loan debt service!!!).
The reality is that under these conditions, the owners of these properties need impeccable execution to achieve the perfect performance projected in their business plans, otherwise they will be faced with severely
diminished returns or even the probability of not making it. Neither outcome would make their investors and lenders happy campers. However, regardless of effort, life is nothing like an Excel spreadsheet and under the circumstances referenced above, this may be a very tall order to meet... therefore, more likely than not, many of these project sponsors will be forced to sell in order provide (or dare we say salvage?) their LPs with close to decent returns and keep themselves in business.
Mr. Vilenko is an experienced Real Estate professional with over 15 years of experience in real estate investments, including acquisitions, due diligence and asset management. He has held various executive leadership positions focused on private equity, real estate, structured finance and investment banking. Mr. Vilenko leads VTS Capital Partners’ investments process; being responsible for all aspects of the company's investment activities, from deal origination through analysis, contract negotiations, due diligence, project financing, asset management and asset disposition. In prior roles Mr. Vilenko served as Chief Investments Officer for CityR Group and Gaia Real Estate.
VTS Capital Partners “VTS”, is a full service real estate investment and asset management firm, specializing in value-added real estate transactions in the US with a strong focus on income producing properties; mainly in the multifamily and student housing space. Our mission is to provide sophisticated HNW investors and investment groups [family offices] with a platform through which they can diversify their asset allocation and complement their current investment portfolios, by providing them direct access to institutional quality real estate which, to date, has been predominantly reserved to financial institutions
The Article referenced above https://cdn2.hubspot.net/hubfs/157783/June%202017%20CMBS%20Delinquency%20Report..pdf?t=1499266879893