Category: CAP Rates (1)

Source: CoStar News
By: Mark Heschemeyer
Date: July 19, 2018
Link: Distressed

The deal announced this week that private equity firm Stone Point Capital plans to buy Sabal Capital Partners, a small-balance, multifamily lender and loan servicer, is only the latest maneuvering in the shifting landscape for special servicing of commercial real estate loans. More deals are likely as a projected rise in interest rates may boost distress in the market.

Special servicers control the fate of billions in distressed loans and thus the fate of billions in commercial properties. And right now, that is a lucrative market flooded with capital but with fewer investment opportunities capable of providing the higher returns expected from private equity investors.

The jockeying for position is not only indicative of billions of private equity money flowing into distressed assets but also shows where the market is heading.

Driven in part by retail weakness, the volume of loans in commercial mortgage bonds on servicers’ “watch lists” has been on a gradual upswing since last November, according to Morningstar Credit Ratings data. Loans are put on a watch list because of issues such as declining occupancy or net incomes at the properties backing the loans. The rise in volume is considered a reliable indicator of future distress.

The maneuvering is not done, with a prize still to be had. One of the three largest commercial loan special servicers in the market, Rialto Capital Advisors, is still in play. Its owner, homebuilder Lennar Corp., has hired financial advisers to determine Rialto’s strategic alternatives as Lennar shifts to concentrating purely on residential building.

Three of Rialto’s larger competitors are owned by bank holding companies, PNC Financial Services Group owns Midland Loan Services, the largest special servicer in the market; and the second- and fifth-largest are Wells Fargo and KeyBank.

Notably, Wells Fargo is one of the two financial advisers Lennar hired to consider what to do with Rialto. The other adviser is Deutsche Bank.

The fourth-largest special servicer, CWCapital Asset Management, was acquired six months ago by Japanese multinational holding conglomerate SoftBank Group.

Distressed property purchasing is one of the country’s hottest investment categories and the primary target of new investment dollars. At a time when core property prices have hit new peaks, yield-hungry investors are aggressively sourcing new investment opportunities that offer more compelling returns.

Private equity funds raised $14.7 billion alone for value-add and opportunistic commercial real estate last quarter, according to private equity data provider Preqin.

About 75 percent of the new investment money being raised in the market is targeting value-add and opportunistic real estate, the categories that distressed assets fall into, said Chris Lee, vice chairman of CBRE Capital Markets Group based in Miami.

Lee directed one of the largest distressed deals of this year. CBRE, in conjunction with Ten-X, arranged the sale of a foreclosed upon leasehold interest in 110 E. Broward in Fort Lauderdale in January for $41.06 million. Stockbridge Capital Group acquired the 24-story office tower and an adjacent two-story office and retail pavilion. LNR Partners was the seller as special servicer for owner CMBS trust.

“There is no lack of demand for distressed properties,” Lee said of private equity firms. “There is a lot of hidden, and not so hidden, value in these properties.”

At the time of the sale, 110 E. Broward was only 42 percent leased at the time, representing a value-add opportunity by the lease-up of 198,803 square feet of vacant space in a market where the competitive set vacancy is just 8 percent.

In this environment, banks and servicers have had little trouble liquidating the distressed assets. So, the problem for Lee and other brokers is finding inventory right now to sell. The amount of distressed assets in the market at the moment is at post-2008 recession lows as the recovery is now approaching 10 years running.

The amount of foreclosed commercial properties on bank books had shrunk to just $4.7 billion in the first quarter from $31.2 billion seven years ago, according to Federal Deposit Insurance Corp. data.

The amount of specially serviced loans in commercial mortgage-backed securities has fallen by $70 billion in that time, down to about $23 billion.

The diverging trends of money coming in and assets available for liquidation has created a lot of jockeying among special servicers for the dwindling supply of deals. Wells Fargo Bank, PNC’s Midland Loan Services, Rialto Capital and KeyBank have grown their market share in the past two years at the expense of CWCapital Asset Management and other smaller servicers.

Of those loan balances assigned, the amount of distressed loans being actively serviced is small, about 2.4 percent. At year-end 2017, Rialto’s active special-servicing portfolio contained 364 loans and 481 real estate owned properties with a combined unpaid loan balance of $1.98 billion, according to Morningstar Credit Ratings.

In advance of any decision from Lennar about Rialto’s fate, the special servicer has also been particularly active in the past two months growing its special servicing assignments.

Another arm of Rialto has been one of the most active buyers of B-piece commercial mortgage bond offerings. That affiliate has underwritten and purchased over $6.1 billion in face value of such bonds in 88 different securitizations.

B-piece buyers generally purchase the lowest-rated and the very bottom of the bond classes — the unrated class. Any losses to the bond trust come out of the lowest-rated bonds first.

Because of that, B-piece buyers have the right to play an active role in making decisions on important issues that can affect the value of the loan or the collateral. That includes such issues as identifying what collateral goes into the offering and having first-purchase options on defaulted loans or, in this case, appointing new special servicers.

In the past two months, the Rialto affiliate has removed the existing special servicer on 11 different commercial mortgage bond offerings in which it has invested and replaced them with Rialto Capital, according to bond rating agency announcements. Rialto has taken assignments away from Midland Loan Services and CWCapital.

Such removal and replacing of special servicers is not unusual. CWCapital has also won such assignments in the past two months. However, the number of such switches involving Rialto has been much higher than for the others.

Executives from neither Rialto nor Lennar responded to requests for comments for this story.