By Luke Lu, director, Yield Book Mortgage Research
With COVID vaccines being rolling out in the next few months, the CMBS market is hopeful of a swift recovery of the CRE fundamentals. Since peaking in June, the CMBS delinquency rates have been trending down in last five months (see chart below). While the performance of many properties which were doing well pre-COVID is expected to rebound in 2021, it seems likely that the recovery will be uneven across different property types.
While the timeline of a full economic recovery is still uncertain, the market is growing optimistic in a strong rebound of industries like hospitality and tourism, and starts to look past the pandemic for CRE sectors in 2021. That said, we see bifurcations in recovery within each individual property type.
For the lodging sector, we think widely distributed vaccines will benefit leisure travels greatly, but not immediately for business travels. It’s possible that by summer 2021 people will consider it safe enough to drive or take flights to vacation destinations, and the pent-up demand will drive up hotel occupancies and RevPAR. However, business travel is unlikely to return to normal anytime soon as the corporates reconsider the necessity and cost of physical conferences and in-person meetings. Therefore, the upscale or full-service hotels may take much longer to recover than the economy or limited-service hotels. And hotels located in gateway cities and near airports may also experience a slower comeback.
Among retail properties, some of the class A malls and shopping centers with better location and stronger sponsorship might be able to pull through the next few months and emerge as market consolidation winners in 2021 with vaccines bringing foot traffic back, but at the expense of the weaker regional malls that may not survive the darkest winter— record number of store closings is unlikely to be reversed by Christmas shopping and the post-holiday drop of business will take toll. With the accelerated E-commerce trend, the consensus is that the retail sector may face a more bumpy road ahead even with improvements related to the pandemic.
The pandemic impact for offices is still unfolding. We won’t work from home forever thanks to vaccines, but a mixture of onsite and remote working is likely to take a hold, which means reduced office space demand in the future. The CBD or urban office subsector may see continued softness in occupancy and rental rates in the short- and medium-term. We think class A office buildings can be in a better position to have amenity and health safety improvement and attract/keep office tenants following vaccine rollout, while tenants of class B or C properties are more likely to scale back lease space upon renewal or terminate the lease and move up to class A buildings.
While the multifamily sector in general has been resilient since COVID started, there have been challenges in the low- and high-end of the sector. In the low-end, with the employment recovery slowing down in the last few months, many renters are still unemployed and at the danger of losing unemployment insurance benefit right after Christmas if there’s no new stimulus deal. Hence many workforce multifamily buildings may start to be under stress very soon. Meanwhile, some of the higher end apartment buildings in densely populated metropolitan areas have been losing renters who move to suburban area for remote working, but the COVID vaccines now offer hope to bring the professionals, especially millennials, back to 24-hour cities.
In our recently published paper, "CMBS and the Fed…is there a crisis brewing in the office?" we used the Yield Book experimental CMBS credit model to project losses for recent vintage CMBX indexes, and found that under a stressed scenario of 40% CRE price decline across all property types, the losses can reach over 10%, similar to levels experienced by vintage 2007 during the GFC. We acknowledge that such price decline scenarios can be stretched. The reality is there have been very few distressed CRE property transactions (mainly hotels and retails) so far, as most market participants have taken a wait-and-see approach. Hence, we haven’t witnessed plummeting property values across-the-board like what was seen during the GFC.
Given the current positive vaccine prospects, we’d like to adjust the property value projection for a less draconian (and hopefully more realistic) scenario where CRE prices are down in the next 12 months (35% for hotel and retail, 20% for office, 15% for multifamily, and 10% for industrial). And below are the new loss results of the Yield Book CMBS credit model forecasts for the recent vintage CMBX indexes—they range from 5.64% for CMBX13 to 8.53% for CMBX9. The losses are still high, and likely to touch BBB- tranches in many CMBS deals, but they are significantly lower than those of vintage 2007 and 2008 in GFC. We also notice that while as much as 1/3 of the loans are expected to default, the projected severities are fairly modest (mostly around 20%), reflecting the fact that the recent vintage CMBS loans were in general originated with low LTVs to begin with.
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