Analysis by David Salz
There are many reasons a reported first year NOI would reasonably be less than the underwritten NOI; using the latest full year NOI is a better indicator of performance. Using our CMBS data, we examined causes of underperformance among different property types across recent vintages to determine whether it was an indicator of distress.
The chart looks at outstanding loans from recent vintages and various property types that have full-year property performance reported. The impact of COVID-19 has led to bifurcated outcomes for lodging and retail versus multifamily, office, and industrial properties. To measure the incidence of distress for underperforming loan properties, we looked whether the loan has been moved to special servicing or is currently more than 90 days delinquent. The impact of COVID-19 is clear by property type with most distress in lodging and retail loans. While loans with the related property performing more than 5% below the underwritten NOI exist overall, the implication that it leads to a distressed loan was not very clear. Loans with this level of underperformance relative to their underwritten NOIs are no more likely to be in distress than loans performing closer to their underwriting. Looking at the average percentage change, there does not appear to be a systematic bias to overstate.
The underwritten NOI is a single number determined from an in-depth appraisal. However, loans are structured to withstand volatility in income based upon a property type’s characteristics and other specific property characteristics. For example, in structuring a loan for a lodging facility, one would expect to have a much higher volatility in NOI versus a multifamily property, as the hotel is backed by literally overnight leases versus longer-term apartment leases. In other words, it would be expected that the loan for a lodging facility would be structured with more credit protection, including much higher debt service coverage and lower loan to value, than a multifamily property. The ability to accurately forecast a hotel’s NOI is much more challenging than for a multifamily property regardless of an appraiser’s skill set. There exist many other reasons that a property may produce an NOI below the underwritten NOI and still be a well-structured loan. Clearly the underperformance in NOI of a property is less attractive than the performance of its peers, but its incidence directly leading to distress is not apparent in the data.
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.