DBRS Finalizes Provisional Ratings to Independence Plaza Trust 2018-INDP

DBRS, Inc. (DBRS) finalized provisional ratings to the following classes of Commercial Mortgage Pass-Through Certificates, Series 2018-INDP to be issued by Independence Plaza Trust 2018-INDP:

-- Class A at AAA (sf)
-- Class X-CP at BBB (sf)
-- Class X-NCP at BBB (sf)
-- Class X-ECP at B (high) (sf)
-- Class X-ENP at B (high) (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 HRR at B (sf)

All trends are Stable.

All classes other than Class-HRR will be privately placed. The X-CP, X-NCP, X-ECP and X-ENP balances are notional. Classes X-CP and X-NCP reference Class A, Class B, Class C and Class D. Classes X-ECP and Class X-ENP reference Class E and Class HRR.

The collateral for the transaction consists of the fee and leasehold interests in a 1.5 million sf mixed-use residential and commercial complex located in the Tribeca neighborhood of Manhattan in New York City. The property consists of three 39-story apartment towers and connecting townhomes in addition to commercial space. The towers are at 310 Greenwich Street, 40 Harrison Street and 80 North Moore Street. The fee interest covers the entire property, while the leasehold interests relate to three parcels – the South Podium, North Podium and Tower Development – which contain a mix of parking, retail and apartment units. Collateral for the loan consists of both the fee and leasehold interests that cover these three parcels, with the fee owner signing the mortgage loan documents. Loan proceeds of $675 million are being used to retire outstanding debt of $551.6 million ($444.0 million commercial mortgage-backed security mortgage loan securitized in BAMLL 2014-IP and $110.0 million mezzanine loan), return $112.8 million of equity to the sponsor and cover closing costs of $10.6 million.

The three 39-story towers soar above many surrounding low-rise structures in Tribeca, providing tremendous city views as well as great views of the Hudson River, depending on the unit. Adjacent to the property to the north is Citigroup Inc.’s world headquarters and Washington Square Park is directly to the south. The property is within blocks of the Goldman Sachs Group, Inc. world headquarters, the World Financial Center and Tribeca Film Center. In addition, the financial district is within walking distance from the subject and the property is serviced by a reputable public elementary school and an abundance of trendy restaurants, cafes and boutiques. The subject is conveniently located proximate to public transportation, with access to the A, C and E lines as well as the 1, 2 and 3 trains at the Chambers Street station roughly three blocks south of the asset and a Metropolitan Transportation Authority bus stop two blocks east of the collateral.

The property was originally built in 1975 under the Mitchell-Lama Housing Program, an affordable housing initiative for lower- and middle-income families offered through tax breaks and subsidized mortgages. The property exited the program in June 2004, at which time the borrower offered the Landlord Assistance Program (LAP) to any tenants who did not qualify for the U.S. Department of Housing and Urban Development’s Section 8 Enhanced Voucher program (Section 8). The LAP provides an initial below-market rent and annual rent increases based on the New York City Rent Guidelines Board index plus a supplemental growth factor. The strategy for the building is to substantially renovate and roll to market rents both the Section 8 units and the LAP units as they become available. Since exiting the program in 2004, the borrower has invested $58.1 million in renovations to all apartments and has converted 671 units (including units currently vacant and in the process of being renovated), or 50.7% of the residential unit count, into market-rate apartments. Additionally, the borrower overhauled all three lobbies, installed new windows and boilers throughout and added a gym and a children’s playroom at a total cost of $36.6 million. By offering a combination of affordable housing (26.1% Section 8 units and 23.1% LAP) as well as market rent units (50.5%), the property draws in an eclectic mix of old and young, singles and family residents and provides a sense of community in a very urban, affluent neighborhood.

Although there is upside in the attrition of Section 8 units upon renovation, the significant value boost is when LAP units are vacated. The LAP provided tenants with below-market rent upon the property’s exit of the Mitchell-Lama Housing Program and while those units started off lagging the market rent initially, they continue to do so today. The LAP units are and have historically been subject to the New York Rent Guidelines Board index annual rent bumps (plus a supplemental growth factor), but the programmatic increases have never caught up to the market rents achievable in Tribeca. There has been nominal attrition in the LAP units historically; however, the appraiser is expecting this to increase if the regulated rental rate increases continue to exceed the inflation rate. DBRS assumed a 2.7% New York Rent Guidelines Board index annual rent bump, which is equivalent to the 15-year average increase going back to 2003, plus a supplemental growth factor annually until loan maturity.

Management has been able to further increase value by renovating rent-regulated apartments that are vacated and re-leasing them at market rents following a significant renovation. They intend to continue this strategy as these units turn over. In order to compete with the more luxurious products in the Tribeca submarket, the unit renovations are substantial. The kitchens and bathrooms have been completely overhauled with new stainless-steel appliances, cabinetry and tile work, and the rest of the units have received new flooring, new lighting and base and crown molding, among other items. Since January 2015 and as of May 2018, management had renovated 91 apartments, increasing the total renovated unit count to 671. With that said, unrenovated units could vary in condition depending on the degree to which the tenants care for them and their average stay. Based on the unrenovated unit inspected by DBRS, a major gut rehab is necessary prior to re-tenanting. Although no reserves have been set aside to complete ongoing unit renovations once units do become available, DBRS did not give credit to the potential turning over of units. Furthermore, based on the DBRS net cash flow (NCF) and the resulting DBRS Term debt service coverage ratio (DSCR) of 1.49 times (x), the subject is generating a significant amount of excess cash flow that could be used to fund renovations. Since the prior loan was securitized in June 2014, 43 units have been converted from LAP to fair market and 78 units have been converted from Section 8 to fair market. The total share of fair market units has grown to 50.7% from 39.6%.

In addition to the apartments, DBRS considers there to be substantial upside in the existing retail space. Vornado Realty Trust is an experienced retail landlord and one of the largest in Manhattan. Plans have been discussed to alter the streetscape of the existing ground-floor space, including signage, lighting and seating, to maximize the rents of the rolling retail leases while improving the overall feel of the subject to help transform it into a luxury product consistent with the renovated apartment units. This would not only increase the revenue generated from the square footage but would also improve the overall impression of the subject. Market rents for retail along Greenwich Street are reported to be approximately $185 per square foot (psf) to $250 psf, per a borrower representative; however, this exceeds the overall average rent identified by the appraiser of $155 psf for grade-level retail. Either way, both reports lead to the same conclusion that the current rents at the subject, ranging from $7.52 psf to $142.38 psf, are below market. While a renovation and re-programming of the retail footprint may indeed bring tenants who better complement the upscale fair market tenant base, the loan has been structured in a way that eliminates the upside potential from a credit perspective. The three leasehold parcels, which contain all of the retail and parking, can be released subject to the repayment of a portion of the loan based on a release price formula anchored essentially to the greater of in-place cash flow attributable to the released parcel or the cash flow of such parcel at the time of release. As such, the borrower would be incentivized to release the parcels prior to re-stabilization and leverage them separately. DBRS gave no NCF or sizing credit to the upside potential associated with the retail and parking components.

The DBRS value of $644.6 million is a 49.8% discount to the appraised value of $1.285 billion. The appraisal assumes that approximately 18 Section 8 apartments and approximately eight LAP apartments, or 5.0% per year, will turn over per year in its analysis. This turnover rate is consistent with the prior year’s turnover rates. DBRS analysis conservatively assumes that no additional rent-regulated units turn over to market rents. DBRS does make the assumption that the rent-regulated units do, however, achieve estimated programmatic rent increases annually until maturity in 2025. Given the embedded upside in the rollover of affordable rent units, an aggressive 6.75% cap rate was used to determine value. DBRS’s value per unit of $485,753, ignoring retail and parking space, which contribute over $7 million of base rent and $4 million of estimated net operating income, translates to an average psf figure of $546 psf, well below average condo sales psf in Manhattan even after adjusting for the lower quality.

Classes X-CP, X-NCP, X-ECP and X-ENP are interest-only (IO) certificates that reference a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

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 www.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.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.