One part of the commercial mortgage-backed securities market to watch closely for changing dynamics and hidden risk or opportunity is the retail sector.
Some observers find online retail is changing the nature of this property sector, and Moody’s Investors Service said in a recent teleconference it is considering this in its analysis.
The business model for retailers has shifted. Retail and real estate researchers at Moody’s Investors Service have found that retailers are putting more investment capital into Internet strategies than store-based ones, said Tad Philipp, director of commercial real estate research at the rating agency. He also said they are looking to renegotiate leases as they come up in line with a reduced need for space. This has created a situation where lending on bad retail has become one of the fastest ways to lose money quickly in commercial real estate, Philipp warned.
Data from Moody’s Investors Service and Trepp LLC shows that retail properties secured nine out of 12 of non-portfolio/defaulted commercial mortgage-backed securities loans that were resolved with losses greater than $30 million and loss severities higher than 70%. This calls for credit analysis beyond loan-to-value and debt service coverage ratios, Philipp said. Malls, in particular, he said, require a lot of individual attention in analysis.
Part of what complicates retail are the many formats it encompasses, not only in terms of Internet sales and store-based sales, but the fact that—for example—there are lots of places to get groceries today other than the traditional grocery store, Philipp said.
Retail consistently has been one of the largest sectors in commercial mortgage-backed securities, and when combined with office, the two categories represent about two-thirds of the collateral in recent commercial mortgage-backed securities deals, he said. Apartments and hotels are generating revenue, and that is expected to continue, but office and retail are particularly influential sectors.
The Moody’s Investors Service forecast suggests broad-based recovery in net operating income will not occur for two-and-a-half to three years.
Across commercial real estate sectors, multifamily is looking the most favorable in terms of Moody’s Investors Services’ red-yellow-green analysis, which categorizes conditions in property markets based on the colors of a traffic light and their respective supply-demand situations.
Currently multifamily is in a league of its own as a “green” sector, while most other sectors show room for improvement and supply-demand imbalances that put them in the “red-yellow” range, Philipp said.
Also the conduit lending business model remains substantially unchanged from the so-called CMBS 1.0 model and the risk of a race to the bottom persists, he said.
But on the positive side, due to low interest rates, there is good debt service coverage relative to given loan-to-value ratios and good amortization.
Also, tightening in commercial mortgage-backed securities spreads has made commercial mortgage securitizations more competitive for higher quality collateral, Philipp said.
