Loans in Special Servicing: What to Know About Their Appraisals


As the current commercial real estate cycle plays out and the resolution timeline for specially serviced assets lengthens, Morningstar Credit wanted to look at how distressed appraisal valuations have been trending, especially for those that have received multiple appraisals since transferring to special servicing.

Retail: Retail properties have had the steepest valuation declines from issuance — even when compared with office properties — and still account for a large share of the specially serviced loans. However, we expect this trend will eventually shift as older retail loans are resolved and more offices transfer. Most of the retail loans we looked at transferred in 2020, and only a small percentage have transferred since 2022.

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We assumed malls would have the longest specially serviced tenure and also have the most value deterioration, but this was only partially true. While malls had larger valuation declines from issuance than other retail properties, the more recent appraisal trends were slightly more positive for malls. Also, distressed malls were, on average, not specially serviced longer than other retail types (although this may be due to the many COVID-related modifications and extensions).

Sarah Helwig
Sarah Helwig. Photo: Matt Kosterman

We found the largest retail loan in our data set, White Marsh Mall northeast of Baltimore, to embody some of the retail appraisal trends. The regional mall loan is older, securitized in 2013, before the height of the “retail apocalypse.” The property was originally valued at $300 million in 2013, but was revalued at just $124 million in June 2021, after its transfer to special servicing at the height of the pandemic. The property’s cash flow has continued to trend downward as have the subsequent appraisal valuations. The property was appraised at $113 million in March 2022, $100 million in January 2023, and most recently at $95 million in August 2023.

Not all retail property valuations continue to trend downward, however. Another regional mall, Westfield Countryside in Clearwater, Fla., has reported increased valuations since its initial transfer in June 2020. Most recently, the mall was valued at $116 million in October 2023, up 7 percent from the previous appraisal (however, still 57 percent below the issuance appraisal).

Hotel: Hotels are notable in how many have lingered in special servicing since the start of the pandemic, with the majority transferring in 2020. This is especially surprising given the positive performance of many hotels, with 2022 and 2023 cash flows sometimes doubling issuance expectations as conferences and large events resume and work-from-home policies increase hotel nights booked. Still, most specially serviced hotels have received improved appraisal valuations, and only a handful have transferred since 2022.

Reflective of the valuation improvements we’re seeing is the Palmer House Hilton, which transferred to special servicing in April 2020. The first post-transfer appraisal valued the Chicago hotel at just $305.5 million, a 45 percent drop from the initial appraisal two years prior. But each subsequent appraisal has valued the hotel above the last, with the last valuation at $357.1 million in September 2023, above the securitized debt balance.

Office: Office transfers to special servicing have mostly been a post-pandemic occurrence, and, more than any other property type, valuations continue to decline at a steep rate. Many of the offices we’re seeing transfer are older, Class B and C assets that aren’t well positioned to adjust to changing tenant needs.

The Civic Opera Building in the Chicago Loop provides a good example of what is playing out in downtown office space. The loan transferred to special servicing in June 2020 and has steadily lost tenants over the last few years. Originally appraised at $220 million in 2015, the property was reappraised at $165 million in February 2021 and $159.4 million in September 2022.

Echoing a worsening market sentiment, the most recent appraisal in December 2023 came back at just $119.8 million, a 25 percent haircut from the prior year’s valuation and 46 percent below issuance.

The leveling-off of retail (especially regional mall) and hotel valuations is reflective of the glut of loans in these sectors that have been in special servicing since the pandemic and have achieved some level of stability (albeit at levels well below underwritten levels). Distressed office, with very few loans being resolved, has not yet found a floor. This, combined with what we assume will be a steady flow of office loans to special servicing, leads us to believe there is still room for further value deterioration in the sector.

Sarah Helwig is a vice president at Morningstar Credit Analytics.