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The troubled real estate market has created a buyers’ market for mortgage loan portfolios, RMBS and CMBS, foreclosed real estate, real estate in corporate turnaround situations, equity and debt of housing-related retailers, and equity, debt and assets of distressed builders. Hear a panel of experts share their insights on market timing and the importance of proactive planning to achieve investment success.
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Merrick

NEW YORK CITY-US CMBS delinquencies rose 54 basis points in September, ending the month at 3.58%, according to Fitch Rating’s latest Loan Delinquency Index. Leading all property types was lodging, which had the largest proportion of delinquencies at 5.83%.

“The recent surge in hotel defaults is consistent with Fitch’s view that hotel property values will decline by as much as 50% from peak levels,” says Fitch managing director and US CMBS group head Susan Merrick. “While budget hotels have fared best during the downturn, continued pressure on the luxury, resort and gaming sub-sectors will likely push lodging delinquencies to approximately double that of other property types.”

In September, lodging surpassed multifamily with the highest percentage of late pays. In descending order, the other property-type delinquency rates came in at multifamily (5.72%); retail (3.65%); industrial (2.96%); and office (1.97%).

According to Fitch, newly delinquent hotel debt last month included 26 loans totaling $1.1 billion, of which 92% by balance defaulted during the loan term. The largest of those fresh defaults was a $587.7-million note attached to the $4.1-billion Extended Stay America portfolio loan, which is backed by 681 financed and leased hotels located across 42 states.

The borrower filed for chapter 11 bankruptcy protection in June, and court-ordered adequate protection payments have been remitted since approval of the cash collateral order. Accordingly, Fitch anticipates that the loan may be re-classified as “current” in future remittances. However, a potential correction of the loan is unlikely to reverse the rising CMBS and hotel-specific delinquency rates.

Also included in September hotel delinquencies is the $207.9-million Resorts International - Casino Portfolio loan, which consists of three hotel and gaming assets in two states. The loan became delinquent due to a significant decline in cash flow at the properties. Though it is classified as a mixed-use property due to a land component in its collateral, the declining performance and default on the $192.5-million Maui Prince Resort also indicates weakness in hotel fundamentals--particularly in those loans underwritten to a stabilized cash flow at issuance, Fitch maintains.

According to Britt Johnson, a senior director a Fitch in Chicago, lenders that hold these troubled loans have two choices. “They will work with borrowers who are likely able to continue to operate the properties,” she says, “or borrowers who can contribute some addition equity, whether it’s paying down the loan or increasing the amount in their reserve accounts. In those instances, they may continue to work with borrowers and potentially modify loans. In other cases, they may have to take title and foreclose.” In some instances, the hotel may be sold. “It will depend on the property,” Johnson says.

“There may be some assets where [a lender] might have good offers and in those instances they may be able to sell right away. In other cases, they may not and they may have to hold assets until some liquidity returns and they can sell them.”

Recent changes to the REMIC law could also impact how special servicers deal with problematic CMBS loans. These modifications allow master servicers to address problems earlier in the workout process. “Before the changes, a loan needed to be transferred to special servicing before it could get workout attention, which usually occurred only two to three months prior to maturity or default,” says Jeffrey Davis, executive vice president at Jones Lang LaSalle Hotels. “Now, borrowers are able to approach their lenders well in advance and begin negotiating a solution that allows both lender and borrower to recoup additional value.”

Despite some trepidation in the marketplace that these changes would result in a flood of modification and extension requests on the desks of already-burdened servicers, Davis says that has not occurred. “Rather it has given servicers time to direct borrowers to develop comprehensive strategic plans that illustrate the financing and disposition difficulties in the market specific to their asset, and develop well thought out business plans that address impending issues,” Davis says. His company is currently working with several hotel owners to assist them in this process. “The key to getting a swift, positive response is to arm the servicer with the information they need to take action,” Davis details, “which usually includes a broker’s opinion of value, data points from the debt markets and a clear operational plan.”

Some balance-sheet lenders have emerged for office, retail and multifamily properties and the CMBS market is showing a few signs of life. Yet lodging properties still have a difficult time obtaining debt.

“Top-shelf hotel deals can get financed at low leverages and with pricing in the 8% to 9% range,” Davis says, “but the majority of hospitality assets have too much ‘hair’ for lenders right now. As a result, leverage right now means maintaining what you have. Working with your lender to strategically restructure is the key to being in a position to capture the expected recovery in the travel industry.”

Once the economy recovers, hotel properties will follow, albeit with a bit of a delay. “As with all commercial real estate, there is generally a lag between the performance of the assets and the economy,” Johnson says. “It depends on when the economy comes back, but it will be at least two years.”