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The Pandemic Could Do Permanent Damage To Hotel, Retail CMBS Markets

The coronavirus pandemic has decimated retail and hospitality buildings’ cash flows and thus their owners’ ability to pay back their loans.

Commercial mortgage-backed securities backed by retail and hotel properties have gone delinquent and been sent to special servicing this year at a higher rate than ever before. Until the property owners either get some form of financial relief from the federal government or the economy returns to pre-pandemic conditions, the situation has little hope to improve.

Trying to wait out the market slowdown or fight through the difficulties for too long can actually worsen the problem. In some cases, CMBS bondholders will never recoup the losses they are incurring right now, and the pain in the market could affect the investment landscape for years. 

The Montgomery Mall in the Philadelphia suburb of North Wales, Pennsylvania, as of 2016

While the majority of the debt serving real estate is private and thus difficult to analyze, CMBS loans require transparency by law. Their structure is such that missed payments or other distress come to the fore quickly, making CMBS loans a suitable leading indicator for the health of a particular asset class. For retail and hotel-backed loans, that health seems to be very poor.

About 25% of all hotel-backed CMBS loans were in special servicing in October, while 18% of retail-backed CMBS loans were in the same situation, according to data from credit monitoring firm Trepp. That is a mild drop from the year-to-date peak in September. But while fewer loans are sliding into delinquency now, fewer loans are emerging from distress, and the average delinquency period for outstanding loans of all types increased, the Mortgage Bankers Association reports.

“In a lot of ways, we’ve already seen the stress we’re going to see for those properties and we will just keep working through it,” MBA Vice President of Commercial/Multifamily Research Jamie Woodwell told Bisnow. “For other property types, we haven’t seen stress for properties affect the loans, whether because of the types of leases they sign or something else. So each type of property will come through this in a very different way.”

CMBS loans are also distinct from most other types of real estate debt because they are nonrecourse. A borrower can choose to surrender the property’s deed in lieu of foreclosure and walk away without putting any other assets at risk. 

Giving away a property affects the borrower’s reputation, which could potentially make CMBS lenders leery of doing further deals, but otherwise it leaves the debt owner holding the bag in far from ideal circumstances. If more borrowers give up on the prospect of repaying their loans, it would mean heavy losses for the purchasers of commercial securities and distressed assets hitting the market. If a borrower holds out hope for longer before ultimately giving up, the building loses even more value when it goes into foreclosure, Lightbox General Manager Richard West said.

Once the coronavirus releases its grip on society, the primary source of hotel distress will evaporate, but the industry’s path to recovery is uncertain and dependent on the resumption of tourism and business travel. Since CMBS loans are often the choice of borrowers who can’t get the terms they need from traditional lenders with low risk tolerance, widespread deed-in-lieu decisions or foreclosures could erase a subset of hotel owners who lose their last avenue for debt financing.

Retail real estate’s woes were well-documented before the pandemic hit and accelerated the trends that were leaving it behind, and there is no guarantee that properties in distress will regain value at all. As well-capitalized owners walk away from more properties voluntarily, they broadcast a lack of confidence in the sector, which could have widespread ripple effects.

Tied Up In Special Servicing

If a CMBS borrower shows any signs of distress, whether by missing loan payments or disclosing an imminent danger of doing so, lenders are highly motivated to send the loan to special servicing. Only a special servicer can grant forbearance or modify the terms of a loan, and once a property backing a CMBS loan is in special servicing, any leasing or capital expenditure decision must be approved by the special servicer. 


The companies that handle the most special servicing assignments are the same financial giants who have massive market share in many other areas of real estate debt. Wells Fargo, PNC Real Estate/Midland Loan Services and KeyBank are the three largest special servicing entities in the CMBS marketplace, according to MBA.

Depending on who you ask, special servicers are either diligent stewards of a property that turn over every stone in the search to bring a loan back to good standing, or they are corporate drones whose blasé attitude toward the properties they are assigned further ensure those properties’ doom.

“What you’ve been seeing this year is servicers working with individual properties to figure out what’s the best path from where we are right now,” Woodwell said.

“One of the complaints I’ve heard often is that special servicers are just on salary, and their lives don’t change regardless [of what happens to a property],” West said. “They might not look at the big picture, rather just the [special servicing] process, so they’re not incentivized to make a decision. I’ve heard borrowers complain that special servicers are bureaucrats who don’t really care over and over.”

The surest path for a property in special servicing back to good standing is an open line of communication between borrower and special servicer, Woodwell and Commercial Real Estate Finance Council Managing Director of Industry Initiatives Kathleen Olin agreed. But special servicers can subvert a borrower’s attempts to recover by either failing to respond promptly to time-sensitive opportunities or vetoing deals that would trade some short-term cash flow for long-term value.

“You’re a borrower, and suddenly you’ve got all these restrictions on what you can spend capital on, and you can’t do anything long-term,” West said. “If you have an opportunity to land a quality tenant that would require paying upfront tenant improvement costs or giving a free rent concession … typically, you’re restricted to short-term decision-making.”

Being forced into short-term decisions can ensure that a property continues to lose value as it lingers in special servicing, West said. If special servicing hampers the decision-making of CMBS borrowers, then a longer time spent in special servicing would make the road to recovery less likely — a notion Olin contests.

“Length of time in foreclosure is not as important as what you’re doing with it when you have it,” Olin said. “It’s only a bad thing if you’re holding onto real estate and not moving it forward by managing it properly or continuing to lease it.”

Regardless of the potential effects, sources interviewed for this story unanimously agreed that CMBS loans will spend more time in special servicing through the pandemic than in previous years, whether because of increased workloads for the servicers or persistent uncertainty in markets that make long-term financing decisions virtually impossible.


For properties that fell into distress in the first few months after the initial outbreak, forbearance was almost universally the first option special servicers turned to. Many believed the coronavirus could be dealt with by summertime, so allowing borrowers to hold off on payment for a few months with the expectation that they would still settle up fully by the time the loan matures was an easy decision. As time has dragged on and forbearance periods ended, nothing is easy anymore.

“In terms of what lenders are going to do, it’s hard to say because we just got great news about a vaccine,” said Amrik Singh, an associate professor at the University of Denver’s Fritz Knoebel School of Hospitality Management. “So it’s a waiting game to see how long they can hold out, whether through doing another forbearance or modifying the loan.”

If an owner is not showing any indication of being able to add value to a property, a special servicer that has entered into foreclosure proceedings can have the court appoint a receiver who is legally obligated to strive for the best outcome for both lender and borrower, Olin said. 

Other options available to special servicers include extending the terms of the loan or modifying the payment plan in some way, but those are predicated on the borrower being able to make at least partial payments from property cash flow or capital reserves. Without the borrower’s cooperation, foreclosure is just about the only option available.

CMBS Distress And Slim Chance For Survival

Underwriting standards in the CMBS market had been growing in aggressiveness in the years since the financial crisis, Singh said. Regulations passed in 2015 and enacted in 2016 demanded that lenders who packaged loans into CMBS keep a small percentage on their books. Ensuring that such entities retain “skin in the game” produced what’s now known as CMBS 2.0, even safer than the post-recession CMBS loans given by a chastened debt market. 

Though the pandemic has been hard on everyone in the hotel and retail sectors, CMBS loans taken out in the frothy first half of the previous decade make up the large majority of loans in distress now, according to Trepp and DBRS Morningstar.

“What happens in a lot of these deals is that hotel [values] are overestimated,” Singh said.


Some value overestimations could be due to more than just aggression; a whistleblower complaint in May accused CMBS originators of systematically overstating the value of properties backing their loans. A research paper released in August from the University of Texas reported that at least 28% of properties backing CMBS loans had their cash flows overstated in origination documents, though that study has yet to be peer-reviewed. 

When a CMBS loan is sent into special servicing, it triggers a new appraisal of the properties backing it. So far, appraisals since the pandemic began have brought back valuations at a steep discount — 27% on average — from what they were when the loans were originated. The unprecedented market conditions surely account for a large portion of that drop, but these early write-downs could be on properties owned by the most prudent borrowers, ones who saw the fundamentals shift and got out quickly.

“I actually think some of it comes down to pride, with a lot of people saying, ‘I’m not going to give up until I have no choice,’ even though it might have made more sense to give it up in March,” West said.

With appraisers likely swamped with the number of loans in special servicing, getting back the new valuation — an absolute must for a special servicer to determine the right path forward — could be delayed for weeks, West said. If delays mean further value loss, then appraisals will continue to spiral downward.

As special servicers weigh their options, more and more borrowers are throwing in the towel and voluntarily surrendering deeds in lieu of foreclosure. For some, it may be a last resort to avoid a court proceeding when prospects for recovery are slim already. But when retail giants Simon Property Group and Brookfield choose deed-in-lieu proactively, it could sound alarm bells for owners of all similar properties.

“It’s important for everyone to know that even though Simon and Brookfield are well-positioned and have good financial positions, they’re still willing to walk away from properties at a loss,” DBRS Morningstar senior analyst Alex Sgorlon said on a November webinar about the CMBS market.

The biggest borrowers are secure in the knowledge that they can continue to find lenders even after burning those holding the CMBS bonds they abandoned, but smaller operators that are giving up under more pressure or being forced into foreclosure imperil their chances at ever getting a CMBS loan again.

Sam Chandan, dean of the New York University Schack Institute of Real Estate and the Larry & Klara Silverstein Chair in Real Estate Development & Investment

“Borrowers have to consider the reputational effects in the marketplace,” CREFC’s Olin said. “[Previous property surrenders] are a significant consideration for lenders in the marketplace and investors in the marketplace.” 

Along similar lines, though the largest CMBS buyers are major financial institutions with sophisticated enough portfolios to weather losses, smaller entities could be in for some pain on their balance sheet — pain that will only worsen if the process toward foreclosure is elongated.

Once a property is either surrendered or foreclosed upon, it falls to the last holder of the loan to either make something work with the property or try to sell it to a distressed asset buyer. Such buyers are surely out there and waiting to pounce, but when purchasing out of foreclosure, the relative lack of information they get before the deal is closed means they demand a steep discount, West said.

As special servicers work through their backlog, more properties will inevitably hit the distressed asset market, which could deepen the discount that buyers demand. That would be compounded if the retail market overall fails to substantially recover from the pandemic, and if the hotel market does not bounce back immediately.

“Given historical patterns of seasoning and distress in previous cycles, it’s likely that the peak in distress is still ahead of us,” New York University Schack Institute of Real Estate Dean Sam Chandan said. “The outcomes depend significantly on the availability of a vaccine and our ability to resume the kinds of activities that support hotel and retail demand.”

The quickest to act will have a head start on the market, especially because the transition between taking ownership of a property and being ready to sell is not immediate.

“[Debt holders who take possession] have to stabilize the property in order to dispose of it, so there’s property management issues, leasing issues, tenant service issues that they have to get involved with before they can dispose of the asset,” CBRE Global President of Debt and Structured Finance Brian Stoffers said.

Some holders of surrendered or foreclosed properties will surely take the opposite approach, opting to hold until market conditions improve or attempt to stabilize properties themselves so that they don’t have to expose themselves to the distressed asset market. The most relevant recent history did not reflect kindly on that approach.

“A lot of lenders in 2009 played the waiting game by putting properties in receivership and waiting for a better market,” Singh said. But compared to lenders who sold earlier, “it didn’t work out at a greater rate.”