KBRA Sees Risk Ahead for Many CMBS Loans
The credit rating agency thinks that CMBS ARAs ‘have reached an inflection point’ and sees more potential for trouble ahead.
As the country entered the uncertainty of 2023, valuations and the need for price discovery have become growing issues in commercial real estate. In some areas, valuations have been taking a large drop. Finance costs are a challenge, especially if plans originally had involved cheap interest rates and large degrees of leverage. Expectations of ongoing large rent increases have already run their course.
“We’re moving from a 15-year artificially inflated environment of low interest rates and value inflation that the Fed created to keep the economy going and that real estate in particular benefited from,” Eisner Advisory Group consultant Joseph Rubin told GlobeSt.com in the fall of 2022. “Now we’re probably going to revert to the historical mean here.”
With that much fog, it’s no wonder that the question of what properties are worth seems to be coming up with lenders. KBRA thinks that appraisal reduction amounts (ARAs) in CMBS are a sign that needs attention.
“With the economy continuing to contract, property fundamentals weakening, and prices under pressure, KBRA believes that CMBS ARAs have reached an inflection point,” the company wrote. “In the coming year, we expect to see more ARAs get triggered due to higher loan defaults as well as increased ARA amounts as property valuations decline. In addition, we also analyze their reliability as an indicator of future potential CMBS loan losses, as well as how deals with high ARA exposures can result in a shift in the controlling class.”
KBRA has seen the implementation of 80 ARAs, with a total value of $635.2 million, from January through November 2022. As of that end month, across 322 loans there were $3.6 billion of ARAs outstanding.
“When looking at the differences between ARAs and realized losses as a percentage of outstanding loan balances, 46% of the loans were within a plus or minus 10% range and 70% were within 20%. Less than 3% (8 loans) varied by a plus or minus 50% range,” they wrote.
Clearly the effects aren’t even across all property types. “In total, 64.7% of the outstanding ARAs by dollar volume are collateralized by retail, with malls accounting for 68.7% of retail ARAs,” KBRA noted. There were 90 lodging ARAs. Of those, two chains — Hilton and Holiday Inn — reportedly accounted for 13 loans each for a total of 30%.