Analysis by David Salz and Thomas P LaSalvia, PhD
Transparency is an important virtue in the commercial real estate (CRE) market. The industry trade association, Commercial Real Estate Finance Council (CREFC), has been successful in creating a gold standard of transparent reporting on the complexities of CRE performance and related impact on the structure of commercial mortgage backed securities (CMBS). With kudos, CREFC sought to provide guidance early in the spring when it was clear that the COVID-19 crisis indicated challenges to transparent reporting.
Illiquidity is frequently viewed as inconsistent with transparency. In fact, both can be true at the same time and we are witnessing this currently in the commercial real estate market. Sales data is transparent but in reviewing recent sales since March, the depressed sales volumes, which for some metros is less than 15% of last year’s volume, are indicative of an illiquid market where buyers and sellers are waiting for better reasons to transact. At the national level, for Q2 only, the industrial sector has year-over-year volume of greater than 50%; multifamily, office, retail, and hotel volumes fall between 35% and 45% of last year’s figures. Given the lack of sales it is difficult to deduce trending values. For example, while the Q2 average apartment price per unit of $193,000 was well within the range of recent averages, the $955 per SF average for the office sector (more than 3 times recent figures) indicates that only very high-value properties have been transacting.
This brings us to the reappraisals that we find reported through CMBS. From the beginning of March through last week, we see over 200 observations of properties being reappraised through the special servicing process comprised mostly of retail and hotel properties. Appraisers depend upon sales data, cash flow analysis, and, yes, other appraisals. Without an active market, we have to expect that these appraisals rely upon historic prices and fundamental cash flow analysis. This is our first glimpse into where value is headed.
In spite of having limited observations, we divided our observations between the March to May time frame and the June through September time frame. Our logic was that the early months of this period could include properties that were already in special servicing prior to COVID-19 and the reductions in appraised value would be more severe. We are glad that we did split the observations as we witnessed very different average reductions between the time frames, with lodging and retail declining in the later period roughly 20% and 25%, respectively, versus 58% and 51%, respectively, in the earlier period. A review of these observations by loan origination vintage didn’t yield a meaningful trend at the moment. The takeaway today is that the indicated reductions are neither a ceiling nor a floor for value changes in the coming months; however, the magnitude of the change does help inform us of the types of changes expected and to be followed in the coming months.
David Salz leads the Moody’s Analytics CMBS desk within the Structured Content Solutions group, providing timely and insightful data analytics to CMBS and CRE professionals. Prior to his current role, he managed the ABS desk and worked on various CLO related projects.
Thomas P LaSalvia, PhD is a Senior Economist in the research and economics department at Moody’s Analytics REIS.