CRED iQ Holiday Catalog: REO Assets in CMBS as the End of 2021 Approaches
“Commercial real estate (CRE) professionals are in the midst of the holiday season and while some may reminisce about the glory days of the Sears and JCPenney holiday catalogs, others are closing deals for now-vacant Sears and JCPenney retail boxes,” wrote Marc McDevitt, a senior managing director at CRED iQ. “CRED iQ welcomes the CRE community in finding their next gift (opportunity) with an examination of commercial real estate properties that are real estate-owned (REO) within the commercial mortgage-backed securities (CMBS) realm.
“As of October 2021, there were approximately 350 properties in CMBS transactions that are REO. Unpaid balances for these properties total approximately $5.2 billion. However, distressed assets typically have additional amounts due in terms of property protection and debt service advances by servicers, which in this case total about $584 million — for a total exposure of approximately $5.8 billion. These REO assets have a finite holding period and will be sold to the market at some point in the future. Special servicers, on behalf of CMBS trusts, are generally required to sell REO assets by the end of the third year following a title transfer but may be granted extensions under certain conditions. Circumstance provides opportunity for distressed investors, especially with a notable increase in volume of distressed CRE opportunity funds that have seeded in 2021.
“The vast majority of CMBS REO inventory is retail, accounting for 47 percent of the aggregate outstanding debt for all REO properties. Office — 21 percent of the total — and lodging — 15 percent — round out the top three property types. Akin to a Teddy Ruxpin or limited-edition Squishmallow, manufactured housing and industrial REO assets are positioned as the hard-to-get property types with limited inventory. There were only three manufactured housing properties and 11 industrial properties that were REO.
“From a historical perspective, the total number of REO assets has declined by 5 percent over the prior 12 months. The decline in the number of REO assets was led by retail, which saw a net reduction of about 60 assets over the course of a year. However, as the number of retail assets has been trending downwards, the total number of REO hotels has more than doubled in the past year — increasing by a factor of 2.4x. The number of office properties, though, has declined year over year, exhibiting a 40 percent decrease. Despite reductions in the number of REO assets, the total outstanding debt on REO has increased by approximately 13 percent. The most logical explanation is that REO assets with smaller unpaid debt amounts are also generally smaller basis properties that can attract a wider range of acquisition prospects and more efficient closings. High-basis assets, especially those in severe distress or in need of capital expenditure and repositioning, with large outstanding debt amounts, may have more limited buyer pools. This is most evident with retail REO inventory, which had its outstanding balance increase by $201.6 million, despite approximately 60 fewer assets. Smaller community centers and strip centers were liquidated, while regional malls at a larger basis remained unsold and had limited buyer pools.
“Of the largest REO assets by total exposure, six out of 10 are regional malls. The remaining four are office properties. The highlighted regional malls have been REO for an average of just under three years — the title to Ingram Park Mall in San Antonio was most recently conveyed to the special servicer in April 2021. Portals I, an office property in Washington, D.C., has been REO for more than five years, which is the longest among the Top 10. Value depreciation of these assets may be the most noticeable at first glance. Seven of the 10 properties have been reappraised and the average decline in value compared to loan origination was 70 percent, a glaring example of the severity of distress present with REO assets.
“Looking ahead, there are over 350 properties totaling close to $5.7 billion that are delinquent with a workout strategy of foreclosure cited by servicers. These properties serve as the potential pipeline for additional REO assets. However, workouts of CRE properties are very fluid and often do not result in the acquisition of title by special servicers and lenders. Regardless, distressed investors should not limit their opportunities, and explore these properties as additional options.
“Happy holiday hunting!”
NOTE: This is an edited and condensed version of a CRED iQ report that was published earlier this month.