DBRS Finalizes Provisional Ratings on GS Mortgage Securities Corporation Trust 2017-FARM

DBRS, Inc. (DBRS) finalized its provisional ratings on the following classes of Commercial Mortgage Pass-Through Certificates, Series 2017-FARM issued by GS Mortgage Securities Corporation Trust 2017-FARM:

-- Class A at AAA (sf)
-- Class B at AA (sf)
-- Class HRR at AA (sf)

All trends are Stable.

Additionally, DBRS withdrew the rating on the following class, as it was not issued:

-- Class X-A

The subject property consists of a 2,031,293 square foot (sf) office park comprising five Class A office buildings and two retail buildings in Tempe, Arizona. The property was built by State Farm Mutual Automobile Insurance Company and its affiliates (State Farm) in 2016 for an estimated construction cost of $700.0 million to $750.0 million ($345 per square foot (psf) to $369 psf) per the appraisal. In December 2017, the property was sold to a joint venture (JV) between JDM Partners LLC (JDM) and Transwestern Investment Group (Transwestern) for $930.0 million in a sale-and-leaseback transaction from State Farm.

The subject property is located in the Mill Avenue District of Tempe, which is quickly becoming one of the most desirable submarkets in Phoenix. This submarket has experienced a flurry of new development, as large block office tenants have led the transition to brand-new, modern office buildings. Development is robust, with several projects completed within the past few years and several more underway, as evidenced by the numerous construction sites and cranes visible to DBRS at the time of the site inspection. Until recently, the Mill Avenue District comprised primarily Class B office space, pedestrian-friendly retail and numerous vacant lots. However, its location just across the newly filled Tempe Town Lake allows for beautiful waterfront views and has transformed the area into more of a live-work neighborhood. Furthermore, the location offers walkable access to downtown Tempe (0.5 miles) and is adjacent to Arizona State University (ASU), highways and public transportation. CoStar reports that in the Tempe submarket, Class A vacancy is only 5.8% and the average rental rate is $33.61 psf (gross), or approximately $24.00 psf on a triple net (NNN)–equivalent basis, just slightly below in-place rents at the subject. The subject is located on the northern border of the Tempe submarket in a less heavily developed area, with the surrounding properties including comparable offices, new multifamily space, vacant parking lots and a run-down flour mill, which is why the road is named Mill Avenue and the greater area is named Mill Avenue District. Although the subject is located in a less developed portion of the Tempe submarket, it is in the natural path of future development and benefits from close proximity to the nearby light-rail commuter station and good access to Loop 202 (Red Mountain Freeway).

State Farm, a high investment-grade-rated company, strategically chose this location in an effort to consolidate small regional offices within the Greater Phoenix area and because the neighborhood has the ability to attract and retain a talented workforce. This location houses all facets of State Farm office operations, including a State Farm call center, automobile insurance, home insurance, banking, executive space and back-office space. State Farm’s five leases are for 100.0% of the office space, the first of which has an initial lease term through November 2032, and the remaining leases have staggered expirations two to three years apart, with the last lease ending in November 2042. Furthermore, there are no termination options within any of the State Farm leases. Its current lease rate of $26.00 (net) is in line with both the appraiser’s market rent estimate and similar lease comparables. The loan has been structured with an anticipated repayment date (ARD) after ten years and a final maturity date five years beyond the ARD. This five-year tail allows for substantial principal repayment prior to the first State Farm lease expiry in 2032. Additionally, the DBRS property net cash flow (NCF) analysis is highly dependent upon income generated from State Farm, and any future downgrades to State Farm’s credit rating may affect DBRS’s analysis and ratings on this transaction. In addition, the amortization credit DBRS gave to the ARD period is highly dependent on the rating of State Farm.

The sponsor for this loan is a JV between JDM, a full-service private real estate development and management firm based in Phoenix, and Transwestern, an investment advisory group serving institutional clients that is considered strong given its local expertise and long history with State Farm. Both companies’ extensive experience in institutional real estate ownership and management will benefit the subject property. The sponsor is contributing $375.0 million of new cash equity to the transaction, with Transwestern rolling over its existing $22.5 million implied equity stake in the property to the new ownership structure as well.

The DBRS loan-to-value (LTV) ratio and DBRS Refinance LTV are 88.0% and 52.6%, respectively, based on an 8.75% cap rate, with the DBRS value representing a 33.7% discount to the appraised value. The DBRS cap rate is far above the current market cap rate (as estimated by the appraisal) of 5.25% and 196 basis points above the cap rate implied by the sponsor’s $930,000,000 purchase price and Issuer’s underwritten NCF of $63,137,233. Given the property’s above-average quality and leases to a long-term credit tenant, there is limited term default risk. Refinance risk is also minimized as a result of the ARD structure where the loan begins to hyper-amortize in year ten through year 15, resulting in a loan balance reduction of 40.3% at final maturity.

The office buildings, which represent 98.7% of DBRS revenue, are leased to (with such leases guaranteed by) State Farm, a high investment-grade-rated tenant, with five separate leases with staggered expiries beginning in November 2032 and going through November 2042. All leases extend beyond the ARD in 2027, with one lease expiring at final maturity in 2032, and there are no termination options.

The loan has been structured with an ARD, whereby it begins hyper-amortizing after year ten of the loan. After the ARD, all excess cash flow remaining after paying interest on the outstanding principal and accrued interest at the initial interest rate will be applied to paying down the principal balance of the loan. DBRS estimates the loan’s maturity balance at final maturity in November 2032 at $334.3 million. This 40.3% expected amortization because of the ARD structure results in a maturity balance of just $165 psf and an exposure that is less than half of the original construction cost. Further, because of the staggered nature of the lease expiries, there is still a substantial $53.9 million of NNN rent being paid by State Farm after final maturity, stepping down with each further lease expiry in 2035, 2037, 2039 and 2042. DBRS estimates that the loan balance could potentially be paid down to less than $150.0 million when the cash flow available from State Farm after final maturity is considered, though lack of repayment in 2032 would trigger a balloon default, so DBRS did not assume this lower balance in its analysis.

The subject is aesthetically appealing and has a very high quality architectural design. The built-to-suit campus was completed in 2016 and contains critical back-office operations with convenient access to transportation as well as a location fewer than 4.0 miles from Phoenix Sky Harbor International Airport.

The subject is 96.8% leased by one tenant. The property is leased to a high investment-grade tenant with a very low risk of bankruptcy. However, because the DBRS property NCF analysis is highly dependent upon income generated from State Farm, any future downgrades to State Farm’s credit rating would likely affect DBRS’s analysis and ratings for this transaction. In addition, the credit DBRS gave to the ARD period is also highly dependent on the rating of State Farm. State Farm has five separate leases that have staggered expiries, with the first expiring in November 2032 (21.7% of State Farm’s net rentable area (NRA) and 21.0% of the overall NRA), and even if State Farm were not to renew that lease, the remaining four leases adjusted for inflation would result in a DBRS debt service coverage ratio in excess of 2.0 times. The State Farm leases are staggered with a two- to three-year buffer between expiries that allows management ample time to re-lease one building before another lease expires. The offices were built in a manner that enables them to be easily re-leased to another single tenant or as a multi-tenant space. According to the appraiser’s dark value estimate, the subject has a value of $573.0 million ($283 psf), which is only $13.0 million more than the initial loan amount but $238.7 million higher than the DBRS estimated loan balance at final maturity.

Although the subject is located in the booming Mill Avenue District, it is located along the northern border in a less developed area with room for additional competition. There has already been a significant amount of new development in the area, with nearly 2.3 million sf of new supply being introduced over the past ten years; however, the submarket had been able to absorb the new supply at a rate of approximately 178,200 sf per year. DBRS believes that at the time of the first State Farm lease expiry, the neighborhood will be more fully built out and in a more mature stage of development. The subject is located in a highly desirable area with great waterfront views on one end and the ASU football stadium on the other. The subject is conveniently located approximately 0.4 miles from a light-rail train stop. Furthermore, the city plans to extend and add an additional 66.0 miles to the light-rail system with a stop planned in front of the subject by 2020.

The loan has a high initial loan psf of $277, especially given that the lowest rating on the certificates is very high at AA. The loan hyper-amortizes in years ten through 15, with a final maturity balance of $165 psf, which is a similar exposure to the DBRS-rated SkySong Center, an office property located approximately 4.0 miles north of the subject, at $160 psf that was successfully securitized and has been performing since 2013. The subject property is considered superior in quality, tenancy and location to SkySong Center. Furthermore, the exposure falls to $123 psf when adjusted for approximate 2.0% inflation over the 15-year loan term. Another comparable DBRS-rated property, Cityscape – East Office/Retail, an office building located in the Phoenix central business district approximately 10.0 miles west of the subject, is more comparable in terms of quality and location to the subject. The whole-loan balance for this property was far higher at $288 psf when securitized in 2014, and the value was $427 psf. Finally, the initial loan balance of $277 psf is high considering office sales within a 2.0-mile radius of the subject averaged $253 psf across nine transactions over the past two years, according to Real Capital Analytics. However, the subject is of extremely high quality and the investment-grade tenant’s income alone provides for substantial amortization down to a fraction of replacement cost.

The loan has no carveout guarantor or environmental indemnitor. The transaction results in an implied $400.0 million of equity based on the difference between the market value of the asset and the loan amount. Per the environmental site assessment from 1955 to 1970, the land was unoccupied; following that, the land became a parking lot. As a result, there is extremely low risk of future environmental issues resulting from the history of the land. Furthermore, the subject had a clean Phase I environmental assessment.

All ratings will be subject to ongoing surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed or discontinued by DBRS.

For more information on this transaction and supporting data, please log into viewpoint.dbrs.com. DBRS will continue to monitor this transaction with periodic updates provided in the DBRS Viewpoint platform.

Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS was provided with the Form ABS Due Diligence-15E (Form-15E), which contains the description of the information that the third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While DBRS did not require due diligence services outlined in Form-15E, DBRS did use the Data File outlined in the Independent Accountant’s Report in its analysis to determine the ratings.

The principal methodology is North American Single-Asset/Single-Borrower Methodology, which can be found on dbrs.com under Methodologies. For a list of the Structured Finance related methodologies that may be used during the rating process, please see the DBRS Global Structured Finance Related Methodologies document on www.dbrs.com. Please note that not every related methodology listed under a principal Structured Finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrs.com.