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The next economic crisis: empty commercial spaces

There is also a fear that directing significant relief to the industry could be seen as a “subsidy to the president’s friends” since Donald Trump made his fortune in commercial real estate, a frustrated lobbyist over the lack of traction said the issue. is getting along with the politicians.

“Sometimes people forget the depth and breadth of what commercial real estate is,” said Mike Flood, senior vice president of commercial and multi-family policy at the Mortgage Bankers Association. “What is at risk here is both the ability for people to stay in their apartments and the ability for people to go to work. So unless there is a stimulus, there is much less to return to. back to normal times. “

A major problem is that no one knows how long the decline in commercial real estate will last. Business travel is not expected to resume for at least a year, so hotels are being hammered. And while office buildings have not yet suffered the brunt of the recession ̵

1; offices tend to have long leases – that will change all businesses rethinking how they operate as working from home becomes the norm.

The number of commercial loans that have been packaged into securities that go into “special services” – in which bad loans are passed on to a new manager hired by bondholders to negotiate a payment plan on their behalf – has steadily increased since March.

And it has become clear that the virus will continue to slash revenue for some time, so even those homeowners who have been able to patch up payments – thanks in part to the now-expired Congressional-approved relief measures – may begin. to slip.

Losing tenant payments could result in a wave of property writedowns and possible foreclosures on everything from shopping malls to condos. But it’s not just a pocket of wealthy investors that will get hurt due to widespread devaluations. Eighty-seven percent of public pension funds and 73 percent of private pension funds hold real estate investments.

Borrowers seeking loan reduction or considering refinancing are also facing problems, as the uncertainty caused by the virus has left them with no clear projection of future income streams for their buildings.

“Every lender is trying to help regardless of the form of financing, but sooner or later the borrower needs customers,” Flood said.

The damage is already manifesting itself in the securities market, where mortgages are packaged into bonds sold to investors, which are then repaid by mortgage payments.

One in five loans grouped into commercial mortgage-backed securities are found on checklists for special services, where loan managers – the companies that collect mortgage payments and advance them to investors – report potential obstacles to future payments, such as a important tenant who moves.

As the crisis has hit some places and sectors much harder than others, it is difficult to get a complete and clear picture of the problems in the market, one of the reasons why lobbyists have struggled to convey urgency to policy makers. Some assets have been wiped out, while others are thriving.

Hotels and retail, which together make up 40% of the commercial mortgage-backed securities market, were the hardest hit. Months after the lifting of the lockdowns, 1 in 2 hotel rooms remain empty. Urban hotels, which have some of the highest operating costs, fare worse, with only 38% occupancy.

And retail, which was already in trouble before Covid hit thanks to the rise of e-commerce, has seen its decline accelerate. It’s not just about small malls – the owner of the $ 1.9 billion Mall of America struck a deal with his special service in August to avoid foreclosure.

A quarter of all CMBS hotel loans are in special services today, up from just 1.9% at the end of 2019. And 18.3% of retail loans are in special services, up from 5% at the end of last year. year.

Condominiums, on the other hand, have performed well so far. Industry analysts are eagerly watching for signs of more tenants not renting now that the initial spurt of economic relief included in the Congressional $ 2 trillion CARES Act passed in March is fading.

Apartment owners are also hampered by a nationwide ban on eviction for non-payment of rent put in place by the Centers for Disease Control and Prevention last month. The order did not include any rental assistance funding, effectively requiring landlords to subsidize homes for troubled tenants until the December 31 deadline.

“The worst case scenario is that you take the shiny asset of all commercial real estate and potentially create a liquidity crisis and, frankly, a situation where people are put on the street,” Flood said. The unfunded eviction ban, he said, “transfers the risk to the borrower and the lender.”

Homeowners trying to get some relief from their loans, meanwhile, are having problems, especially in cases where the loan has already been packaged in a collateral.

“The difficulty here is that both the borrower and the lender have to determine what the asset is worth today,” said Lisa Pendergast, executive director of the Commercial Real Estate Finance Council, a trade association representing lenders, investors. and mortgages.

“Where do you think the value of your property will be in three months, six months, six years?” Pendergast said. “It depends.”

Part of the problem is that there haven’t been enough commercial property transactions – sales fell 68% in the second quarter from the previous year – to gauge how much property values ​​have really fallen, leaving buyers and sellers with very divergent views. on what a property is worth.

The lack of clarity about the present value of a property is particularly important for small, grouped securities loans held by investors. A bank can give a borrower some short-term relief and reassess the problem in a few months, while a borrower whose loan has been bundled into a security has to go through a more complex process to get approval from various investors to adjust the payments.

Special servicers have to model future payments for bondholders, a difficult task when the value of a building is unclear now or whether it will generate revenue anytime soon.

“This is where the whole thing breaks down – not knowing the value of a property,” said Michael Bright, CEO of the Structured Finance Association, a trading group representing 370 companies involved in the securitization. “It’s a pretty important input and nobody knows.”

A survey conducted in May by the American Hotel and Lodging Association found that only 15% of borrowers whose loans had been packaged and sold to investors had received loan relief, compared with 80% of borrowers with homeowned loans. banks.

Consider a hotelier whose business was good before Covid hit. If the owner’s loan is held by a bank, they can work out, for example, a six-month deferral plan or a longer-term loan with the bank to keep things going until a vaccine is in place. .

But if the loan has been sold to investors in the securities market, the owner is ready for full monthly payments, which the servicers forward to the investors. He can work with the servicer on deferral of payments, but investors, depending on the risk they are exposed to, may hesitate.

In the long run, the source of funding doesn’t make much of a difference: Eventually, a bank will have to devalue a property it doesn’t recover. And industry analysts aren’t sure which properties will.

“The main question is probably around structural economic changes or changes in buying and living behavior,” Bright said.

“I think everyone is trying to understand what a post-Covid world means for commercial real estate,” he said. “Hopefully people will want to travel and get together again soon, but we don’t know yet.”

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