DBRS Morningstar Finalizes Provisional Ratings on SREIT Trust 2021-FLWR

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Commercial Mortgage Pass-Through Certificates, Series 2021-FLWR issued by SREIT Trust 2021-FLWR (SREIT 2021-FLWR):

-- Class A 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.

DBRS Morningstar discontinued and withdrew its ratings on the Class X-CP and X-NCP interest-only (IO) certificates initially contemplated in the offering documents, as they were removed from the transaction.

The SREIT 2021-FLWR single-asset/single-borrower transaction is collateralized by the borrower’s fee-simple interest in 16 Class A multifamily properties totaling 5,260 units across six states in the southeastern United States. An affiliate of Starwood Real Estate Income Trust (Starwood or the sponsor) is using loan proceeds of $796.5 million ($151,426 per unit), along with borrower cash equity of $387.5 million, to acquire the portfolio for approximately $1.1 billion ($216,300 per unit). The sponsor is in the process of acquiring one of the properties, Century at the Ballpark, and the acquisition will likely be finalized after the transaction's closing date. An earn-out escrow in the amount of $41.09 million will be established at closing and will be released to the sponsor once the acquisition of Century at the Ballpark has been finalized. If the property is ultimately not acquired, then the earn-out proceeds will be used to pay down the principal balance. For the purposes of net cash flow (NCF), valuation, and sizing analysis, DBRS Morningstar assumed that the sponsor completed the acquisition of Century at Ballpark.

The properties generally exhibit high-quality finishes and comprehensive amenities as they all were constructed between 2006 and 2017, and seven of the assets, totaling 2,432 units, were built within the past five years. In addition to the high-quality collateral, DBRS Morningstar generally views the markets contained in the portfolio as highly desirable for multifamily development, with strong growth potential and favorable population statistics. A significant portion of the portfolio is in Texas and Florida, representing 78.2% of the total units in the portfolio and 76.8% of the total purchase price. Recent population data indicate these two states have had the most success in attracting new residents. Both Texas and Florida were two of the 10 fastest growing states between 2010 and 2020, according to census results. Texas saw a population growth rate of 15.9% and Florida experienced a population growth rate of 14.6% over that time period, both significantly higher than the national population growth rate of 6.6%.

Although the portfolio is currently well occupied with a physical occupancy rate of 95.9% as of April 27, 2021, rental collections have not been as strong. Specifically, between May 2020 and April 2021, the portfolio achieved monthly collection rates between 95.6% and 97.1%. Furthermore, the portfolio collected about 96.3% of rental payments on average over the trailing 12 months (T-12) ended April 30, 2021. These collection figures are generally above the national averages provided by the National Multifamily Housing Council, which reported collection rates ranging from 93.2% to 95.9% between January and May 2021. However, the subject collection figures are still weaker than what newer Class A multifamily assets are typically able to achieve. In addition, although the assets are generally in high-growth markets, the DBRS Morningstar Market Ranks associated with the individual assets are generally considered weaker than more densely populated urban locations. Approximately 58.2% of the portfolio is in a DBRS Morningstar Market Rank of 3 or 4, which indicates a more suburban location and generally exhibits higher historical probabilities of default within the conduit universe. However, the cross-collateralized and geographically diversified nature of the portfolio mitigates some of the market risk.

The transaction benefits from experienced sponsorship in Starwood, a private investment company with significant ownership and management experience in commercial real estate around the world. Founded in 1991, the firm has approximately $80 billion in assets under management and has acquired more than $115 billion of real estate assets, including properties within every major real estate asset class. Starwood also has significant experience in the multifamily space as the company and its affiliates own nearly 350 multifamily properties totaling approximately 88,000 units nationwide. Furthermore, Starwood owns 265 properties totaling 72,000 units that are in the same markets or metropolitan statistical areas (MSAs) as the properties contained within the portfolio. The portfolio serving as collateral for the SREIT 2021-FLWR transaction was acquired through a public, nonlisted, externally managed real estate investment trust that had approximately $6.2 billion of assets under management as of March 31, 2021.

Compared with other property types, multifamily assets generally benefit from staggered lease rollover and lower expense ratios. While revenue is quick to decline in a downturn because of the short-term nature of the leases, it is also quick to respond when the market improves. During the Coronavirus Disease (COVID-19) pandemic, multifamily properties have been much more resilient in generating cash flow and collecting rent when compared with other property types such as retail and office.

Loan proceeds and borrower contributed equity of $387.5 million (34.1% of the total purchase price) are being used to acquire the collateral in an arm's-length transaction, representing significant skin in the game for the sponsor. DBRS Morningstar generally views acquisition financings more favorably as the sponsors are generally more committed to the collateral’s success when they have significant cash equity at stake.

In addition to being in high-population-growth markets, the assets have also experienced strong year-over-year rent growth as the properties have been successful at attracting and retaining tenants while still raising rents. For instance, in Q1 2021, there were 1,193 leases signed including both new and renewal leases, representing 22.7% of the total portfolio units. These leases were signed at rental rates that were on average 3.6% higher than the previous leases for the same units.

The properties securing the transaction are generally in strong, high-growth markets. The population of the MSAs contained in the portfolio on average grew at a rate more than double the growth of the United States between 2010 and 2019. Approximately 78.2% of the units are in Texas or Florida, which are two of the fastest growing states in the U.S.

The portfolio allocated loan amount is not heavily concentrated on one particular asset. The average allocated purchase price is 6.3% across the portfolio, with only one property (Travesia) accounting for more than 10% of the total purchase price. Furthermore, no asset makes up more than 10% of the total portfolio’s net operating income over the T-12 ended March 31, 2021. As a result, a temporary cash flow decline at one property will likely not result in a debt service shortfall.

Although the portfolio was well occupied as of the date of this report, the historical occupancy of the portfolio is slightly weaker. The portfolio was approximately 90.6% occupied in January 2019 and approximately 92.8% occupied for F2019. If occupancy reverts to levels experienced in 2019, revenue could decline and lower the cash flows available to service the loan. Furthermore, collections at the property for the T-12 ended April 30, 2021, were approximately 96.3%, which adds additional economic loss to the portfolio’s revenue.

The loan has a partial pro rata/sequential-pay structure, which allows for pro rata paydowns across the capital structure for the first 20% of the unpaid principal balance. DBRS Morningstar considers this structure to be credit negative, particularly at the top of the capital stack. Under a partial pro rata structure, deleveraging of the senior notes through the release of individual properties occurs at a slower pace compared with a sequential-pay structure. To account for this structure, DBRS Morningstar applied a penalty to the transaction’s loan-to-value (LTV) hurdles.

The borrower/sponsor/arranger can release individual properties with customary debt yield and LTV tests. The prepayment premium for the release of individual assets is 105.0% of the allocated loan amount (aggregate prior releases must not exceed 15.0% of the original principal balance) and 110.0% of the allocated loan amount for the release of individual assets thereafter. Because these release premiums are designed to reduce the risk of adverse selection over time, DBRS Morningstar considers the release premium to be weaker than a generally credit-neutral standard of 115.0% and, as a result, applied a penalty to the transaction's capital structure to account for the weak deleveraging premium.

The DBRS Morningstar LTV on the $796.5 million whole loan is substantial at 120.6%. To account for the high leverage, DBRS Morningstar reduced its LTV benchmark targets by 2.5% across the capital structure. The high leverage point and the lack of scheduled amortization pose potentially elevated refinance risk at loan maturity. The DBRS Morningstar LTV on the last dollar of rated debt is much lower at 98.5%.

The loan is full-term interest only (IO), providing no reduction in the loan basis over the loan term. The lack of principal amortization increases refinance risk at maturity. The DBRS Morningstar NCF results in a strong total debt IO debt service coverage ratio (DSCR) of approximately 3.07 times, providing a significant amount of cash flow cushion in times of economic turmoil. However, the interest rate on the debt is floating and based on one-month Libor, which is at a historic low and could increase in the future, plus a spread of 160 basis points. Any marginal increase on the base rate will incrementally lower the DSCR and cash flow cushion for the portfolio.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

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

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is North American Single-Asset/Single-Borrower Ratings Methodology (March 2, 2021), which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. 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.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar 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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