There continues to be much talk about the CMBS wall of maturities and what is still left to be refinanced in 2017. There’s a lot of concern that all the good ones are gone – likely no Class A properties left, much multifamily has already been refinanced by agency lenders – and that what is left are assets that may have a little hair on them. So this raises two main questions:
- What exactly is left? What kind of assets and issues are you likely to find? How should you approach due diligence for these presumably troubled assets?
- Who will take these on? Who has the risk appetite? How can they minimize risk during rehab/repurposing?
I’ll tackle both questions in this 2-part series. As for the first part…let’s define what “a little hair” might look like…
What is Left?
Well, your guess is as good as ours. But the industry speculation is that there are a lot of secondary market office, retail, and certain types of industrial assets left. With each of these classes, there are concerns over vacancies, how well the current asset is being maintained, and what can be done to stabilize, repurpose or otherwise make the asset more attractive.
If that assumption is true, then what are some of the physical asset issues to be on the lookout for as these refi’s come up?
Understanding the Condition of the Asset
If the asset is vacant, clearly maintenance (or lack thereof) could be a big issue. Even if the asset is occupied but is underperforming, there’s a greater chance that it is not being maintained very well. In these situations we see a lot of deferred maintenance on things like roofs, asphalt and other hardscapes/landscape areas of the property. Also, overdue replacement of big ticket items such as the roof, HVAC, or elevators can be a concern.
That makes doing a Property Condition Assessment absolutely essential. The appraisal may alert the lender to such physical condition issues, but will not detail thoroughly what immediate repairs and capital expenses are needed to bring the property back to life.
If this becomes a foreclosure or special servicing situation, understanding life and safety issues becomes critical. Once a lender takes ownership they inherit the liability for things like structural issues or even trip hazards at a property, which is something the PCA will identify.
Is There a Hazard on Your Hands?
If the asset isn’t being maintained, you’ll want to be on high alert for hazards like mold or moisture intrusion, or damaged asbestos containing materials. Especially if a rehab is planned, these are items that may need to be factored into the costs – asbestos sampling and removal or encapsulation, mold removal, lead paint inspection and removal.
For industrial sites, are there hazardous materials stored on site? Who will properly remove or dispose of it? Has good housekeeping been maintained? Have the operations contaminated the soil or groundwater? Even if a Phase I ESA was conducted at loan origination, by the time of a refi conditions could have changed substantially. At the very least a Phase I ESA Update would be wise.
For retail sites, two big environmental red flags are: is there, or was there, a dry cleaner or gas station on-site or nearby? If so, you will want to assess the potential for soil or groundwater contamination, or a vapor intrusion issue.
Who’s Up For It?
I realize I’ve just painted a fairly doom and gloom scenario, and certainly not all assets left in the wall will be so troubled. But it’s part of the concern over how the CRE industry will digest this hairball. So who’s got the fortitude for it? The speculation is that many of these assets will need to be repositioned and therefore loans from bridge, mezzanine or hard money lenders will be utilized as the asset undergoes rehab or repurposing in order to be more attractive. That process comes with its own set of risks, so in part 2 I’ll discuss how these investors and debt partners can minimize the risk for a successful outcome during repositioning.