DBRS Morningstar Confirms Ratings on DROP Mortgage Trust 2021-FILE

DBRS, Inc. (DBRS Morningstar) confirmed the ratings on the Commercial Mortgage Pass-Through Certificates, Series 2021-FILE issued by DROP Mortgage Trust 2021-FILE as follows:

-- Class A at AAA (sf)
-- Class A-IO at AAA (sf)
-- Class A-Y at AAA (sf)
-- Class A-Z at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class X-NCP at BBB (sf)
-- Class D at BBB (low) (sf)
-- Class E at BB (sf)
-- Class HRR at BB (sf)

All trends are Stable.

In addition, DBRS Morningstar discontinued the rating on Class X-CP as the bond has exceeded its stated maturity date of July 2022 and is no longer receiving interest payments.

The rating confirmations reflect the stable performance of the transaction, which remains in line with DBRS Morningstar’s expectations at issuance. The transaction is collateralized by the borrower’s fee-simple interest in The Exchange, a 750,370-square foot (sf) office building with retail components in the Mission Bay submarket of San Francisco. Built in 2018, the subject is in excellent condition and is LEED Platinum certified. The office property consists of 12 stories with ground-floor retail space and boasts design elements, including building systems and floorplates, that can accommodate life sciences tenants. The property benefits from its dense urban location near many of the area demand drivers, such as the University of California San Francisco’s Mission Bay campus, the Golden State Warriors’ Chase Center, the Kaiser Permanente hub, and new residential units. The property also benefits from the experienced institutional sponsorship of KKR.

The floating rate loan is interest only (IO) and is structured with an anticipated repayment date (ARD) in April 2026 with 10 successive one-year extension options and one six-month option for a final maturity date in October 2033, one month before Dropbox Inc.’s (Dropbox) lease expiration. In addition to penalty interest due on the mortgage after the ARD, the loan will hyper-amortize to the extent of available excess cash flow. This feature strongly incentivizes the sponsor to arrange takeout financing before the ARD and therefore reduces maturity risk for the certificate holders.

The largest tenant is Dropbox, which at issuance occupied 98.4% of the net rentable area (NRA) on a lease through November 2033. Approximately 186,500 sf (25.3% of the NRA) was subleased to Vir Biotechnology, Inc. (133,896 sf, 17.8% of the NRA) and BridgeBio Pharma, Inc. (52,604 sf, 7.0% of the NRA). Dropbox’s lease is backed by a letter of credit of approximately $34 million and, while the tenant does not have termination options structured into its lease, the borrower has the right to amend the lease and reduce Dropbox’s footprint by up to 250,000 sf provided no event of default occurs. According to the servicer, in December 2021, in exchange for a $32 million termination fee and $10.5 million tenant improvement allowance contribution, Dropbox gave back the space that was subleased to Vir Biotechnology, Inc., and the borrower converted the sublease to a direct lease at a market rental rate of approximately $76 per sf (psf), which is above Dropbox’s below-market rate of approximately $68 psf. As such, Dropbox now occupies 80.5% of the NRA and, according to the September 2022 rent roll, the property was 99.6% occupied. Aside from BridgeBio Pharma, Inc., other sublease tenants now include The Regents of the University of California (45,287 sf, 6.0% of the NRA), and Latch Al, Inc. (13,164 sf, 1.8% of the NRA), representing approximately 111,000 sf (18.4% of NRA) of total subleased space.

According to various news outlets, Dropbox listed most of its space on the sublease market after electing to move to a remote-first work policy and opting to retain only 90,000 sf as collaboration space in late 2021. The property owners have re-branded the property, changing the name to Icona: Labs at Mission Bay to boost the property’s new purpose of providing lab space in a market where life sciences real estate demand outpaces supply. According to the property manager, Longfellow, build-out of the unused Dropbox space into “turnkey labs to accommodate life sciences tenants of all sizes on a move-in ready basis” began in H1 2022 and the owners are actively marketing more than 406,000 sf of Dropbox's space as lab-capable space available for lease. According to the West Coast commercial real estate firm Kidder Mathews, while there remains a significant amount of available office space in the San Francisco County market, the lab vacancy rate is low at 4.6% as of Q3 2022, with asking rents holding steady between $75 psf and $120 psf compared with the subject property’s average in-place rental rate of $69.05 psf.

According to the financials for the trailing nine months ended September 30, 2022, the servicer reported an annualized debt service coverage ratio (DSCR) of 3.34 times (x), an improvement from the YE2021 DSCR of 3.24x but below the DBRS Morningstar DSCR of 4.99x at issuance because of interest rate volatility as the debt service amount has increased from issuance. However, annualized net cash flow (NCF) for the same period was $56.4 million, compared with $39.2 million as of YE2021 and the DBRS Morningstar NCF of $47.8 million at issuance, likely because of the Vir Biotechnology, Inc. direct lease conversion at a higher rental rate. It was noted at issuance that, to extend the loan, the borrower must also obtain a replacement interest rate cap agreement or propose an alternative hedging instrument that would provide protection from increases in interest rate. Given that Dropbox continues to lease most of the space on a long-term lease, DBRS Morningstar expects the loan’s performance to remain in line with expectations but notes there may be upside potential if the borrower exercises its right to reduce the footprint covered by Dropbox’s below-market lease further, charging Dropbox a termination fee, and simultaneously backfilling the space at a market rate.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929 (May 17, 2022).

Class X-NCP is an IO certificate that references 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 are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

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

The principal methodology is North American CMBS Surveillance Methodology, 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.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

The rated entity or its related entities did not 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.

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

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