DBRS Morningstar Finalized Provisional Ratings on KREST Commercial Mortgage Securities Trust 2021-CHIP, Series 2021-CHIP

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of KREST Commercial Mortgage Securities Trust 2021-CHIP, Series 2021-CHIP, as follows:

-- Class A at AAA (sf)
-- Class X-A at AA (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 (sf)

All trends are Stable. Class HRR is not rated by DBRS Morningstar.

Class X-A is an interest-only (IO) class whose balance is notional.

The KREST Commercial Mortgage Securities Trust 2021-CHIP single-asset/single-borrower transaction is collateralized by the fee-simple interest in HQ @ First, a 603,666-sf office campus in San Jose, California. The campus consists of two seven-story office buildings and one four-story building that has 543,000 sf of office space (90.1% of NRA) and 60,000 sf of data center and research/lab space (9.9% of NRA) and a parking garage. The property was designed and constructed in 2010 as a build-to-suit for network equipment producer Brocade Communications Systems, which occupied the campus until its acquisition by Broadcom, Inc in 2017. In 2019, Micron Technology, Inc (Micron) executed a 16-year lease for 100% of the property to serve as its Silicon Valley headquarters. Micron is the fourth-largest semiconductor company in the world and is rated Baa3/BBB- by Moody’s and Fitch, respectively.

The property benefits from long-term, institutional-quality tenancy with a remaining lease term of approximately 13.4 years, which DBRS Morningstar believes should largely shield the property from any short- or medium-term dislocations in the local office and technology market resulting from the ongoing Coronavirus Disease (COVID-19) pandemic. Micron leased the entire property with the intention of growing into the space over time. Prior to the Coronavirus Disease (COVID-19) pandemic, it subleased 165,790 sf to cloud security company Zscaler, which uses the space as its headquarters on a lease that expires in September 2026. Zscaler currently leases 103,443 sf with contractual expansion options in October 2022 and October 2025. Zscaler’s sublease rent is approximately 4.6% above Micron’s contractual rent as of August 1, 2021.

The transaction sponsor is KKR Real Estate Select Trust (KREST), a private REIT for individual investors sponsored by KKR & Co. Inc. (KKR). As of June 30, 2021, KKR had approximately $428.9 billion in assets under management and raised approximately $94.0 million over the trailing twelve month period and had approximately $31.8 billion in real estate assets under management. The properties will be part of KREST, KKR’s newest private REIT for individual investors. KKR committed approximately $150.0 million to KREST, providing investors in KREST with a fully deployed, income-generating portfolio at launch.. The property will be managed by Drawbridge Realty, a San Francisco-based real estate investment company. In December 2014, Drawbridge and KKR partnered to recapitalize and grow the Drawbridge Realty platform..

The HQ @ First campus is located in Silicon Valley at 110, 120, and 130 Holger Way in San Jose, California. The San Francisco Bay area is home to the highest concentration of technology companies and workers in the country and companies such as Microsoft, Google, Salesforce, and Facebook are headquartered there. The property is adjacent to I-237 with access to highways 880, 680, and 101 as well at the VTA Light Rail, which provides a linkage to Caltrain and offers convenient access to the entire Bay Area. The property is also proximate to the San Jose International Airport and the Milpitas BART station.

Built in 2010, the property is LEED Gold certified and offers high ceiling heights, an onsite solar farm and panoramic windows that offer views of the San Francisco Bay and Silicon Valley hills. The property’s amenities include 1,863 parking spots, a 110-seat theater, a 300-plus seat cafeteria, conference rooms, a 2,000-rack data center, and a fully equipped gym with locker rooms and a basketball court. In addition to 100% investment-grade tenancy, there is no lease rollover during the initial loan term. The WA remaining lease term at the property is approximately 13.4 years, which results in a stable, long-term cash flow stream with 3% annual contractual rent increases. Micron’s lease expires on December 31, 2034, and has two five-year extension options at fair market rate as long as the tenant is not in default under the lease. Micron’s lease has no termination or contraction options during the initial term.

Prior to the coronavirus pandemic, Micron subleased 172,405 sf to cloud security company Zscaler, which uses the space as its headquarters on a lease that expires in September 2026. Zscaler occupies 103,443 with contractual expansion options in October 2022 and October 2025. Per the sponsor, Micron confirmed in its tenant interview that it still plans to expand into this space post-sublease. Micron also confirmed that it is committed to an office-centric work environment as a result of the nature of its business and will not change its overall space needs because of the pandemic.

The DBRS Morningstar LTV is high at 99.7% based on the $408 million in total mortgage debt. In order to account for the high leverage, DBRS Morningstar programmatically reduced its LTV benchmark targets for the transaction by 1.5% across the capital structure.

The loan proceeds, together with an estimated equity contribution of approximately $136.3 million (25.0% of cost) from the sponsor, were used to facilitate the acquisition of the property. DBRS Morningstar typically views cash-in acquisition financings more favorably, given the stronger alignment of borrower incentives compared with situations in which a sponsor is refinancing and cashing out of its equity position.

The nonrecourse carveout guarantor is KKR Real Estate Select Trust Inc., which is only required to maintain a net worth of at least $225 million with no liquidity minimum, effectively limiting the recourse back to the sponsor for bad act carveouts. “Bad boy” guarantees and consequent access to the guarantor help mitigate the risk and increased loss severity of bankruptcy, additional encumbrances, unapproved transfers, fraud, misappropriation of rents, physical waste, and other potential bad acts of the sponsor. The borrower has the right at any time without the consent of the lender to replace the guarantor with one or more of (i) KKR and/or (ii) an affiliate of KKR or KREST; provided that in the case of any replacement affiliate guarantor(s), such replacement guarantor(s), in the aggregate, satisfy the net worth threshold (exclusive of the properties).

The $408 million whole loan comprises eight promissory notes: six senior A notes totaling $230 million and two junior B notes totaling $178 million. The KREST 2021-CHIP transaction will total $267 million and consist of two senior A notes with an aggregate principal balance of $89 million and the two junior B notes with an aggregate principal balance of $178 million. The remaining senior A notes will be held by the originators and may be included in future securitizations. The senior notes are pari passu in right of payment with respect to each other. The senior notes are generally senior in right of payment to the junior notes.

The transaction is structured with an ARD beginning in August 2031 and a final maturity date in November 2034. In addition to penalty interest due on the mortgage after this date, all property cash flow after current debt service will be diverted away from the sponsor and toward amortizing the mortgage loan. This feature strongly incentivizes the sponsor to arrange takeout financing before the ARD date, and therefore reduces maturity risk for the certificateholders.

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.

Class X-A is an interest-only (IO) certificates that references a single rated tranche. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall

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

For supporting data and more information on this transaction, please log into www.viewpoint.dbrsmorningstar.com. DBRS Morningstar provides analysis and in-depth commentary in the DBRS Viewpoint platform.

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 the 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/375376/.

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.

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

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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