A recent RMA article confirmed the growing interest in Commercial Real Estate assets (CRE) beaten down by the Covid-19 lockdown, but a number of other trends are also emerging.
“The pandemic hit the hotel and office leasing businesses hard in 2020. Subsequently, lenders and investors have been closely monitoring their commercial real estate portfolios to reassess asset quality and underlying assumptions.”
Loans on two property types are of particular long-term interest to lenders at this time: hotels and office (particularly office properties secured by B buildings).
According to Credit Trends in Commercial Lending from RMA, the lodging sector showed the weakest credit quality within CRE at the end of the first quarter of 2021. Specifically, about 45% of the lodging sector’s outstanding balance fell into the categories of non-accruing or criticized, the RAS database shows.
In the CMBS hotel loan sector, April was the first increase after five consecutive months of decline, according to Fitch. However, Fitch had anticipated the overall delinquency rate would be volatile as stimulus burns off and coronavirus debt relief expires.
Balance Sheet Weakness
Broken income statements were the common thread through hotel financials in 2020. Of greater concern now are broken balance sheets.
Beyond the cash flow deficiencies tracked by RMA and the rating agencies, a new set of possible disposition candidates has surfaced in the form of hotel operators carrying historically high levels of Payables.
At DebtX, we’ve seen the crushing burden operators are trying to manage. This can be particularly problematic; we have seen situations where trade payables, deferred management fees, past due real estate taxes, bank interest accruals, and deferred franchise fees can amount to as much as 40% of the asset value. Lenders are concerned this is a scenario from which the operator/guarantor may not recover.
In the office loan sector, RMA noted that “rising vacancy rates seen across the office sector may reflect a reduction in demand resulting from 2020’s widespread transition to a remote working environment.” Jones Lang Lasalle, the Chicago-based real estate services and investment group, saw 43% lower global office leasing volumes, year-over-year, as of December 31, 2020, according to RMA.
Other Key Trends
A number of other data points point to some notable trends based on research from Cushman Wakefield (C&W) and CBRE at the end of the first quarter of 2021:
- Larger tenants have given up between 15% and 30% of their space. C&W
- Smaller tenants have either renewed essentially all their space or vacated. C&W
- Leases of less than one year have jumped to 22% of leases written compared to historical averages of less than 10%. C&W
- Covid-related absorption has been worse at negative 138 million square feet compared to the Great Financial Crisis in 2007-2008 at negative 103 million square feet and the Dotcom bust at negative 100 million square feet. C&W
- Negative net absorption of 34.8 million square feet in the first quarter of 2021 was the highest quarterly drop in demand of the current cycle. CBRE
- The overall office vacancy rate rose by 3.7% year-over-year to 16%. During the Great Financial Crisis, the vacancy rate never rose more than 2.7% in a one-year period. CBRE
- Average asking rents declined 1.6% from one year ago. However, anecdotal evidence from various markets showed concessions remained very high, resulting in net effective rents declining more severely. CBRE
Class A Outlook
Additionally, companies are seeking Class A buildings in strategies that are focused on “following the talent.” This has occurred while 63% of product nationally is at least 30 years old and is less suited for retrofitting to meet modern standards.
Clearly, these are interesting market dynamics. They seem to portend a bar-bell view of office product, with the A buildings faring well and B and lesser buildings somewhat up in the air.
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More opportunities – and surprises – may be in store for investors.
With growing uncertainty about the Covid-19 Delta variant, both hotel and office could be facing a new set of challenges in the second half of 2021.
If you are interested in a no-cost, no-obligation evaluation of your hotel and office portfolio, please contact us. .