‘Purgatory’ grips $146 billion of distressed commercial property

Affected borrowers had six to 18 months of debt relief last spring as the pandemic shut down large swaths of the economy and dried up revenues. But almost a year later, some lenders are running out of patience and unable to continue lending.

A glimpse into the future is the $ 540 billion market for mortgage loans bundled in securities. About 7.58% of the total was at least 30 days late in January, led by 19.19% of hospitality loans and 12.68% of retail loans, according to real estate data company Trepp.

The special service rate – a barometer of payment defaults – was 9.72% for the market as a whole, with almost a quarter of loans going to the hospitality industry and 17% of loans going to private customers.

“We have a lot of things in purgatory,” says Manus Clancy, Senior Managing Director at Trepp. “The monthly training notes say the specialist service provider and the borrower are talking about forbearance and renewal.”

About $ 430 billion in commercial real estate debt will mature this year, out of $ 2.3 trillion due over the next five years, according to Morgan Stanley.

This contrasts with the dwindling pile of bad corporate bonds and loans, which has shrunk from nearly $ 1 trillion in March last year to around $ 110 billion as companies exit bankruptcies and markets rebound.

According to the latest data from Preqin, investors raised a record amount of capital for non-performing loan strategies over the past year, and it’s still $ 84 billion on the sidelines. With commercial real estate emergency indicators at their highest since 2013, these investors have plenty of places to put their money into.

“This is by far the most active distressed and opportunistic commercial real estate market I’ve seen in my 15-year career,” said Adam Sklar, portfolio manager at Monarch Alternative Capital, whose $ 9 billion fund specializes in these strategies. Monarch raised $ 3 billion for a new portfolio in December, investing more than 40% of that capital in distressed opportunities including commercial real estate.

And that gloomy picture only applies to debts with strict reporting requirements. There is very little publicly available data on commercial real estate bank lending that is lenient as, according to Clancy, lenders have their own discretion whether to give borrowers breaks and report them.

For example, lenders have allowed borrowers to pay operating costs with funds from reserves, forbearance of debt payments, or postpone due dates, he said.

Even so, bank loan arrears have increased in certain sectors – hotel arrears more than doubled to 3.2% in the third quarter – which tells us that there is a certain base of loan that the bank said, ” This is too far, ”said Clancy.

Some of these loans could fall into the hands of distressed investors as lenders feel pressure to get rid of them. Banks are constrained by regulatory requirements from the 2008 financial crisis that prevent them from holding assets that are deemed too risky.

The Federal Reserve warned of potential sharp declines in commercial real estate and distressed transactions in a report earlier this month, and again on Feb. 23 when Chairman Jerome Powell told Congress he was very concerned and had his eyes on the sector. where some smaller banks are heavily concentrated.

Take Eagle Hospitality Trust, for example, the Singapore-based company that owns hotels in the United States, which filed for bankruptcy after receiving 16 rounds of forbearance from its bank lender, according to court records. Monarch Alternative Capital provides its $ 100 million bankruptcy loan.

The Wardman Park Hotel, a historic Washington, DC hotel, filed for Chapter 11 in January after it was sued by its hotel manager for failing to pay necessary operating expenses, which the lender reportedly failed to fund. The Williamsburg Hotel filed for bankruptcy this week amid a $ 68 million dispute with one of its largest creditors.

The mall’s owners, Pennsylvania Real Estate Investment Trust and CBL & Associates Properties Inc., filed for bankruptcy after receiving temporary debt relief. Washington Prime Group Inc. skipped an interest payment on February 15 while negotiating with creditors to resolve their debt problems.

Many properties never make it to Chapter 11 as property changes hands through foreclosures, replacement deeds, and loan sales. “Jingle Mail” is a jargon for the common practice of a distressed property owner or sponsor who voluntarily hands over the keys to his lender as soon as he can no longer make payments.

Around $ 1.4 billion worth of distressed properties were sold in the fourth quarter, led by hotels, according to Real Capital Analytics.

“A lot will happen in the next two quarters, which gives us an idea of ​​how many distressed assets are entering the market,” said Ben Tschann, a partner at Goodwin Procter’s law firms in the real estate and hospitality sectors. “Will lenders stop being lenient and tighten the screws by opening foreclosure proceedings, appointing beneficiaries, and taking back assets they want to sell?”

The distressed commercial property market was largely frozen in the second and third quarters of 2020 as lenders experienced a kind of “fog of war”, according to Will Sledge, senior managing director of JLL’s capital markets group. Instead of selling in a market where they had no idea of ​​demand, they issued loan waivers and waited for the pandemic to play out, he said.

In the fourth quarter, some financial institutions began selling assets and encountered strong investor demand and aggressive offers. Sledge estimated that JLL traded approximately $ 1 billion in assets in the fourth quarter, up from $ 1.4 billion a year.

Property owners have been very pragmatic about the pandemic, according to Teresa Goebel, chair of Goodwin Hospitality Practice and a member of the real estate group. One large customer who owns about 20 hotels expects to hold all but one, she said.

“We have to wait and see when demand will return,” said Goebel.

According to Joseph Weissglass, managing director of Configure Partners, distressed assets have changed hands due to strong investor demand and the patience of lenders for a post-pandemic recovery, due to strong investor demand and lenders patience for a recovery of the pandemic at a panel at the TMA Distressed Investing Conference on February 23. In addition to the distressed dry powder, more than $ 320 billion has been raised for commercial real estate, according to Preqin.

Whether commercial properties recover quickly or plummet longer depends largely on what happens to the vaccine this year, Sledge said. Nonetheless, he added: “It is a bit presumptuous to assume that with every vaccination the green light is toggled immediately and we immediately go back to basics from 2019.”