Brighton Capital Advisors, a CMBS advisor, works with borrowers to navigate CMBS servicing to find solutions for loans in default and distressed deals. Commercial real estate (CRE) across sectors has faced challenges in the wake of the pandemic, particularly for less-than-stellar Class B and lower properties. CMBS originated between 2017 and 2021 are especially vulnerable, because they were originated at historically low interest rates and high valuations, and the reverse dynamics today have lenders balking at refinancings.
Brighton Capital Advisors is in the thick of it, specializing in CMBS restructurings, modifications, and recapitalizations since its founding in 2020 by managing partner Michael Cohen, who has specialized in CMBS for upwards of 30 years at institutions including Citigroup, UBS, and Deutsche Bank. He spoke recently to Asset Securitization Report (ASR) about challenges faced by CMBS today and how lenders should approach distressed borrowers.
What we find most effective is when the borrower communicates with the servicer before the event of default, in writing.
ASR: From your perspective as an advisor for distressed CMBS, what is the status of the market today?Cohen: Delinquencies have never been higher, and there's a tremendous number of loans being transferred to special servicers, which is not good because that's when high fees occur. And there are not a lot of exit strategies for some of these properties.
ASR: What should CMBS investors want to see from borrowers in distressed situations?Cohen: What we find most effective is when the borrower communicates with the servicer before the event of default, in writing; a pre-packaged workout memo that describes the issue and its proposed solution. The memo should incorporate information enabling the master and special servicers, and the controlling bond-class holder, to discuss the issue and respond to the borrower.
ASR: How often does that happen?Cohen: Ninety percent of CMBS borrowers got a loan through the loan originator and a broker put it together, but now the originator and broker are out of the picture. So that memo is not an easy thing to do for a borrower who may not have the experience or understand the nuances of the CMBS trust tax rules and rating agency implications. People are ultimately going to lose money if the loan is not modified, and that is where the borrower can achieve success. So we find the best results are when there is clear communication.
ASR: What other questions should CMBS investors ask?Cohen: How is the borrower behaving? Are they communicating and sharing accurate property information? Are they showing commitment to managing the assets, and do they have a plan and a model we can be confident in? Does the controlling class holder (the lowest class of bondholder and the ultimate decision maker) want to modify the loan? One issue the special servicers have to contend with is, [if] the current appraised value of the asset is well below the original value, is that a change of the controlling class holder may occur. To avoid the lower bonds being wiped out and force [that] change, which complicates finding a solution, the loan must be modified and restored to performing status. That's why you're seeing lots of modifications happening with shopping malls: They have sufficient debt coverage, while their appraisal values have fallen.
You don't see a lot of sales ... for any [Class B properties], and that means somebody is holding on to them and they're probably underwater.
ASR: What is your view on the overall CRE and CMBS markets now?Cohen: Class A properties have plateaued and are going in the right direction. Class B is stabilizing, but we're at the beginning of a distressed market. You don't see a lot of sales in the marketplace for any [Class B properties], and that means somebody is holding on to them and they're probably underwater.
ASR: Has the general sense of uncertainty in markets this year played a role?Cohen: Lenders' only upside is to get paid interest and their principal back, but they are still investors. If there's uncertainty in the market, why would they want to make an investment if it's uncertain whether there's enough reward for the risk? That's why everybody loves Class A, single-asset single-borrower (SASB) trophy deals now, but shies away from Class B office buildings.
ASR: In which CRE sectors are you seeing the most distress?Cohen: There are issues in every asset class. We're finding that office and multifamily are having the biggest maturity default issues right now.
ASR: Why is that?Cohen: Two things. In the current cycle the loan is over-leveraged, so borrowers have to decide whether they want to deleverage the asset. And more importantly, there's very limited capacity on lenders' balance sheets, for example, to take on more office loans. Only 10% or maybe 20% of CMBS conduit pools are office now, so there's just not a lot of room for those loans. And if you go to the regional or major banks with an over-leveraged Class B office building and you ask them to put it on their balance sheets … why would they do that? They're trying to get rid of those assets.
The big asset class looming in the shadows is multifamily. Nobody talks about the multifamilies in CMBS that were done in 2018, 2019, and 2020. We get calls from people who have Class C multifamilies and there's zero we can help them with. There's no market out there to buy them.
ASR: What about retail and hospitality?Cohen: Hoteliers will tell you that they've already had their crisis in 2020, but back then lenders let those borrowers use their reserves to carry their properties' financing issues, and the franchisors let them delay property-improvement plans and refreshes. That's over. So as a hotel owner today, you're really going to be in a bind if you can't find a loan extension. The economy seems pretty good and people are still going to hotels, but rates are up as hotels seek to pass through higher labor and other costs.
ASR: How will retail fare?Cohen: I think lenders are leaning a bit more toward retail, because it's a little easier to measure than dealing with office right now.
There are only so many large Class A assets that can be singularly securitized.
ASR: What is your outlook for conduit CMBS?Cohen: I think the conduit origination market will get busier and do more flow, but we've gone to a model where every single one of these conduits has to be pre-approved by the B-piece buyer before they close. So the same special servicer who you are fighting with on a loan modification is the one approving your new loan.
ASR: Investors are very much focused on SASB deals, but isn't the supply limited?Cohen: Yes. There are only so many large Class A assets that can be singularly securitized. The question today is when we get through all the big Class A buildings–and we have some really nice but over-leveraged B-class office buildings on Lexington Ave.–what are we going to do with them? If something is overvalued, at some point somebody has to take a loss.
