Trepp: “serious challenges ahead” in CRE

The commercial real estate sector should be prepared for a new cycle of rising defaults, according to Trepp research. Unsurprisingly, the most immediate and severe impact will be in the lodging sector, with a cumulative default rate of 21%. The retail sector will also experience elevated defaults of around 9%.

Trepp applied their forecast scenarios to a portfolio of 13,000 commercial real estate loans, spanning in size, geography and property type. In any version of their predicted recoveries, the report finds it impossible to escape the conclusion that defaults and losses will rise across the commercial real estate industry.

“The weakened economy is virtually guaranteed to lead to higher loan to value (LTV) and lower debt service coverage ratios (DSCR), through reduced income and lower real estate asset valuations,” the report stated.

Impact to the lodging and retail sectors are already apparent. At the beginning of this month, hotel and hospitality business started to pick up gently, as restrictions began to loosen. While many are still hopeful, a new spike in COVID-19 cases means reopening plans are either being paused or even rolled back. The overall lodging delinquency rate had already increased to 19.13% in May from 2.71% the month before, according to another Trepp analysis, totaling about $16 billion worth of loans.

Despite the ongoing battle against the coronavirus pandemic, hotels seem to be generating just enough revenue to cover direct operating costs, with 40% occupancy allowing some limited service hotels to break even, according to data from STR. If occupancy rates drop again due to the spike in new coronavirus cases, lodging will continue to face tremendous burdens.

Special servicing rates surge

Loans going into special servicing continue to swell across the board, with large jumps in lodging and retail. The Trepp special servicing rate increased to 8.28% in June compared to 6.07% the month before.

Retail continues to account for more than half of the new loans transferred to special servicing in June with the servicing rate jumping almost five percentage points to 14.24%. Lodging sits in a close second accounting for about 32% of newly transferred loans with the rate at 20.47% up from 16.21% in May.

A total of 351 new loans were sent to special servicing, plus 243 from the month before hold an outstanding balance of $12.5 billion of loans, according to the report. Almost half of those borrowers are pursuing modifications due to COVID-19.

Impact on multifamily and office, where property owners’ income streams have held up a bit better so far.

“The presence of major government support for the economy and financial markets has helped soften the negative impacts from the COVID-19-induced downturn,” according to the report. “Fiscal and monetary stimulus have been very substantial, and no doubt helped fuel the strong re-hiring seen in May and June.”