DBRS Confirms Ratings of ACRE Commercial Mortgage 2017-FL3 Ltd.

DBRS Limited (DBRS) confirmed the ratings on the following classes of secured Floating Rate Notes (the Notes) issued by ACRE Commercial Mortgage 2017-FL3 Ltd.:

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (low) (sf)
-- Class F at B (low) (sf)

All trends are Stable.

Classes E and F are non-offered classes.

The rating confirmations reflect the overall performance of the transaction, which has remained in line with DBRS’s expectations since issuance. At issuance, the collateral for the transaction consisted of 12 floating-rate mortgages secured by 16 transitional commercial real estate properties, with a total balance of $341.2 million. As of the February 2018 remittance, six loans have repaid out of the trust, including the Brookfield LA Office Portfolio (Prospectus ID#2), which had an outstanding principal balance of $34.0 million and was repaid with the February 2018 remittance. The transaction has a Reinvestment Period that is scheduled to expire on March 15, 2019, that allows the Issuer to replace loans repaid from the trust with newly originated loans. As part of this transaction feature, DBRS will evaluate new loans to assess any credit drift caused by potential loan concentrations and retains the ability to provide a Rating Agency Confirmation for proposed additions to the pool. Since issuance, five loans have been added to the pool with redeployed funds between September 2017 and January 2018. As of the February 2018 remittance, there are 11 floating-rate loans outstanding in the pool, secured by transitional assets in various stages of stabilization. Ten out of these 11 loans, representing 87.8% of the outstanding loan pool balance, have a pari passu companion participation held by a subsidiary of the trust asset seller and sponsor, ACRC Lender LLC.

Based on recently reported quarterly financials and servicer updates, most of the collateral properties are in some period of transition, with sponsors in the process of executing their respective business plans. The underlying loans are structured with future funding components that are generally allocated for renovations and leasing costs for the collateral properties. The current loans in the pool benefit from low leverage on a per-unit basis, with the weighted-average current debt yield at 7.0%, based on the DBRS As-Is Cash Flows and the current outstanding trust balance, which is considered healthy given that the pool consists of stabilizing assets. As of the February 2018 remittance, there are no loans in special servicing and three loans on the servicer’s watchlist, representing 34.7% of the current pool balance. The two most pivotal loans on the servicer’s watchlist are detailed below.

The Marriott Westchester Tarrytown loan (Prospectus ID#4, 12.5% of the current pool balance) is secured by a 444-key hotel located 30 miles northeast of New York City in the Tarrytown suburb. At issuance, the property was undergoing a $13.7 million ($30,743 per key) property improvement plan (PIP), with renovations to the common spaces and the ballrooms, as well as soft goods replacement in the guest rooms, which would bring all spaces up to Marriott brand standards. The loan was originally structured with $2.5 million in future funding to be allocated toward the PIP costs, none of which has been advanced to the borrower to date. The loan was added to the watchlist as a result of the cash flow declines related to the ongoing renovations at the property throughout November 2016 and May 2017. In addition, the loan is on the watchlist due to its upcoming maturity in June 2018 and, according to the most recent servicer update, the borrower is considering a refinance or sale of the property.

During the renovation period, occupancy at the subject has been reported in the 50% range, due to the logistics of renovating rooms two floors at a time. However, according to the September 2017 Operating Statement, the in-place occupancy, average daily rate (ADR) and revenue per available room (RevPAR) metrics have improved to 83.8%, $152.20 and $190.16, respectively, compared with the T-12 ending December 2016 occupancy, ADR and RevPAR of 71.7%, $147.70 and $105.86, respectively. The property remains popular with travellers to Tarrytown and generally received a positive reception following the renovation, with reviews placing it in the top five hotels in the area on TripAdvisor as of February 2018. Although the loan reported a Q2 2017 annualized debt service coverage ratio (DSCR) of 0.66 times (x), which was a decline from the DBRS Term DSCR of 1.21x, DBRS expects cash flows to improve as the renovations have been completed, with all 444 units on line and available for booking. Despite the operational disruptions from the renovations, the hotel has historically been a leader in its market in terms of both occupancy and rate, demonstrating RevPAR indices in excess of 100%. The loan benefits from a seasonality reserve with an ending balance of $408,747 as of February 2018.

The U.S. National Bank Building loan (Prospectus ID#6, 11.5% of the current pool balance) is secured by three multi-tenanted buildings in Portland, Oregon, approximately ten miles southwest of the Portland International Airport. The sponsor has owned the property since 2014 and contributed $13.0 million in cash to close the subject loan. At issuance, the loan was structured with $4.4 million in future funding to facilitate capital improvement projects and leasing, of which $847,376 has been advanced to the borrower to date. The loan was added to the watchlist following the eviction of the largest tenant, Thetus Corporation (Thetus, 15.4% of the NRA), in February 2016, following the tenant’s default on the lease.

Although the sponsor has allocated funds toward immediate repairs, leasing momentum has been slow, with an occupancy rate of 55.9% and an average rental rate of $25.96 per square foot (psf) as of September 2017, remaining relatively unchanged since issuance. The largest three tenants collectively represent 31.1% of the NRA, on leases that are scheduled to expire between June 2019 and December 2024. The largest tenant is U.S. Bank National Association, representing 13.3% of the NRA and paying an average rental rate of $25.96 psf, which is below the Portland office submarket average rental rate of $30.70 psf as of February 2018, according to CoStar. At issuance, the sponsor reported a letter of intent had been received from Adidas AG for the former Thetus space; however, it appears that a lease did not materialized as the space remains vacant, according to the September 2017 rent roll. In addition, CoStar is showing the property as 61.1% leased as of February 2018, with the former Thetus space remaining available for lease. The servicer previously noted that the property was under contract for sale with a targeted closing date of mid-February 2018; as of the date of this press release, DBRS is waiting on a servicer update for the status of that sale. Despite the elevated vacancy at the subject, the borrower has $3.5 million in remaining commitments to facilitate leasing and the loan reported a Q2 2017 annualized DSCR of 0.97x, compared with the DBRS Term DSCR of 0.54x. DBRS will continue to monitor the loan for developments.

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

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

The principal methodology is CMBS North American Surveillance, 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.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

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.

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