MASTER SERVICERS ARE AVOIDING NON-RECOVERABLE ADVANCES (NRAs)

Given the current environment, Master Servicers of CMBS pools on certain distressed loans can be reluctant to make advances that they deem to be potentially “non-recoverable.” These advances are aptly named NRAs as the Master Servicer has concerns that those funds will not be recouped. Master Servicers must conduct their own due diligence on specially serviced loans to determine if they agree with the Special Servicer’s “exit plan” for the asset and if the timeframe to exit is realistic. The decision "to advance" or "not to advance" is in the Master Servicer's control.

Advances made by Master Servicers include monthly principal and interest loan payments as well as other property expenses like real estate taxes and insurance premiums. When a loan sits in special servicing over an extended period where the Borrower has not funded cash flow shortages, the Master Servicer is contracted to make advances so bondholders get paid. While advancing is part and parcel of a Master Servicer’s fiduciary responsibility it is also a profit center for them. Customarily, Master Servicers want to lend/advance on loans. The exception is when the Master loses confidence in the Special Servicer’s ability to get those advances repaid.

THG: Considering the uncertain economic climate and the potential for loans to sit in special servicing for extended periods, we have seen many more loans where the Master Servicer has determined to stop advancing. Check all the loans in your CMBS loan pool to determine if there’s been a shift in bond control due to NRA’s and subsequent appraisal reductions.

OpEx INFLATIONARY PRESSURES HIT MULTIFAMILY BOTTOM LINES HARDEST

Significant inflationary pressure is posing a serious challenge to all CRE loans on operating expenses (OpEx), particularly in areas like insurance and utility costs. Sustained inflation is affecting loans across the board whether it’s CMBS, CRE CLO or a bank or insurance company loan. Multifamily properties operating on tight margins are feeling the pain. Higher operating expenses vis a vis actual rental income growth are putting the squeeze on an Owner’s ability to generate sufficient cash flow to meet loan obligations.

THG: For your maturing loans that require refinancing, expect most Lenders to underwrite operating costs at a higher level than your actual 2024 costs as they adhere to stringent underwriting standards. Anticipate reduced loan proceeds. A 10% debt yield is minimally required. If you do not meet these financing criteria, dual-track a potential modification/ extension with your existing Lender.

NEW CMBS ISSUANCES FAVOR 5-YEAR VS TYPICAL 10-YEAR LOANS

In CMBS CRE financing, a noticeable trend is emerging favoring 5-year CMBS loans over their 10-year counterparts. This shift reflects a strategic response to the evolving economic landscape and market dynamics. With shorter loan terms, borrowers gain increased flexibility and agility in navigating uncertainties, such as interest rate fluctuations and changing property valuations. While 5-year loans offer a lower rate based on today’s yield curve, Borrowers should be aware of the ramifications. In general, we applaud the securitized lending community for adapting a product that the market needs and wants.

THG: We certainly understand the Borrower's perspective but caution Borrowers to continue to think about negotiating extensions upfront. Certain business plans require four years or more to come to fruition. Without a ten-year runway, you may find yourself in a precarious position down the road.

DATA CENTERS DOMINATE NEW BUILDING STARTS

In an increasingly data-driven economy, data center real estate development has surged in recent years. Data centers have become essential components of our growing digital infrastructure, reflecting our reliance on storing and processing vast amounts of digital information to run modern business operations. The proliferation of cloud computing, the rise of big data analytics, and the increasing digitalization of products and services across the board have all contributed to heightened demand.

As businesses seek to enhance their technological capabilities while ensuring robust data security and reliability, the need for purpose-built data center facilities has dramatically intensified. Consequently, developers and investors are increasingly drawn to the lucrative opportunities presented by the CRE sector's expansion into data center development, recognizing its potential for long-term growth and resilience.

THG: Developers and acquisition teams may want to invest in markets where power is plentiful, land may be more affordable, and tax incentives exist. A few of the top locations that support data center development include Northern Virginia, Dallas, Silicon Valley, Phoenix, Chicago, Atlanta, Portland, New York/New Jersey, Seattle, and Los Angeles.

TRENDING STRATEGIES TO REDUCE EXPOSURE AND MITIGATE RISK

In response to the evolving dynamics of the real estate market, particularly in challenging MSAs, financial institutions are turning to strategies to reduce their CRE exposure. Banks are conducting bulk banknote sales to lower their reserve balance requirements. For CMBS loans, loan assumptions provide an avenue for Special Servicers to resolve troubled loans. We are currently working on an urban core Office property in a challenged MSA where value has been significantly eroded. CMBS lenders are demonstrating some flexibility in that they may be willing to discount the unpaid balance (UPB) for a new borrower who injects fresh capital to facilitate property lease-up. This approach not only incentivizes investment but also prevents properties from falling into distress, avoiding the "zombie landlord" scenario.

THG: If your property carries a CMBS loan with 3+ years remaining until maturity and boasts a low interest rate, a loan assumption becomes a valuable tool for sellers of properties. Currently, we are familiar with at least two Special Servicers who are willing to add term to the loan to further incentivize the new buyer.

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