DBRS Morningstar Confirms Ratings on All Classes of A10 SACM 2021-LRMR

DBRS Limited (DBRS Morningstar) confirmed its ratings on the Commercial Mortgage Pass-Through Certificates, Series 2021-LRMR issued by A10 SACM 2021-LRMR as follows:

-- 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 (sf)

All trends are Stable.

The rating confirmations reflect the overall performance of the collateral, which has remained consistent with DBRS Morningstar’s expectations at issuance. The loan is secured by the borrower’s fee-simple and leasehold interests in Larimer Square, a 246,000-square-foot (sf) mixed-use property consisting of retail and office components in Denver. Larimer Square is a protected historic district and comprises 26 buildings, including a parking garage on 12 separate real estate tax parcels. Two of the buildings are subject to ground leases. The four-year loan pays interest-only payments for three years and has a conditional performance test determinant of amortization during its fourth year. The loan is also structured with two 12-month extension options.

The fully funded loan amount of $88.7 million consisted of an initial loan balance of $61.0 million and $27.7 million of future funding. Initial loan proceeds were used to recapitalize the sponsor’s purchase of Larimer Square, while future funding, along with future sponsor equity, will be used to execute the sponsor’s business plan of completing capital improvements and leasing up the property to market occupancy and rental rates. The lender is expected to fund $21.1 million of future funding toward capital improvements and $6.6 million toward leasing costs, with the sponsor expected to contribute $13.3 million of additional equity to help cover capital improvements (a 31.1% share) and leasing costs (a 35.0% share) on a pari passu basis.

The renovations were budgeted at $30.9 million and will be completed in three phases. Phase I consists of repairs to the roof and facades on the majority of the 26 buildings at a cost of $2.3 million. Phase II mainly consists of the redevelopment of the Granite, Buerger-Sussex, and Lincoln Hall buildings to repurpose the space for large office tenant users. In addition, these buildings will receive infrastructure upgrades related to mechanical, electrical, and plumbing with some modifications to ingress/egress points at a total budgeted cost of $16.0 million. Phase III consists of improvements to the streetscape and general improvements to the exterior of the overall property at a cost of $2.0 million.

According to the collateral manager, Phase I is expected to be completed by spring 2023, Phase II is currently in preconstruction, and 36% of the streetscape and general upgrades have been completed. Through November 2022, $3.9 million (20.0%) of the future funding component had been advanced to the borrower as the current funded A note balance is $64.9 million. The remaining available dollars for capital expenditure and tenant leasing costs are $17.3 million and $6.6 million, respectively. It was also noted that the Borrower is considering increasing the scope of the renovation program, budgeted at an additional $17.0 million, which would be funded entirely out of pocket. The borrower has received the necessary approvals required to pursue the additional development with a targeted construction start date in Q3 2023. DBRS Morningstar requested further detail regarding the scope of this work and whether the execution of this project will delay the timeline on the completion of the current business plan; however, an update was not provided by the collateral manager at the time of this review. DBRS Morningstar credits this recent development as a positive consideration in its analysis as it strengthens the sponsor’s commitment to the property.

The sponsor’s ultimate goal for the subject is to develop the property into a 24-hour destination for the local population, while catering to office and retail demands. At closing, restaurants represented approximately 70.0% of the retail space, which the sponsor plans to reduce to approximately 55.0%, with a goal to retain only restaurant tenants with high sales volume. Replacement tenants offering a wider range of goods and services are expected to be targeted to backfill the potential vacant suites. As leases roll, the sponsor plans to increase rents to market, while adding strong and national retailers to its tenant roster. Lastly, the sponsor will be converting office leases to a triple net (NNN) structure upon renewal or new leasing activity.

According to the December 2022 rent roll, the subject was 53.5% occupied, compared with the YE2021 and issuance occupancy rates of 58.5% and 66.0%, respectively. Occupancy is expected to remain depressed as the sponsor continues to implement its capital improvement program prior to initiating its lease-up strategy. According to Reis, retail properties in the Midtown/Central Business District (CBD) submarket of Denver reported a Q1 2023 vacancy rate of 6.6% with an average five-year forecast vacancy rate of 7.5%, while office properties in the CBD submarket reported a Q1 2023 vacancy rate of 22.3%, with an average five-year forecast vacancy rate of 20.2%. DBRS Morningstar analyzed the loan with a stabilized vacancy rate of approximately 10.0% for the entire portfolio, which is in line with the appraiser’s estimate. In regard to rental rates, DBRS Morningstar assumed a rental rate of $50.00 per sf (psf) NNN for both retail and restaurant space with new and renewal leasing costs of $75.00 psf and $40.00 psf, respectively. DBRS Morningstar analyzed office space with a rental rate of $35.00 psf NNN with new and renewal leasing costs of $35.00 psf and $18.00 psf, respectively.

The DBRS Morningstar stabilized net cash flow (NCF) was $7.2 million, a variance of -21.1% from the sponsor’s projected stabilized NCF of $9.2 million. DBRS Morningstar valued the collateral at a stabilized value of $96.4 million based on the concluded NCF and a capitalization rate of 7.50%. The loan is structured with a $25.0 million limited guaranty by the sponsor, which may be terminated upon the loan meeting certain performance metrics including an average occupancy rate of 90.0% for a period of six months, a debt yield of 9.0% for a period of three months, and a loan-to-value ratio of 60.0% based on an updated appraisal.

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 https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

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 the North American CMBS Surveillance Methodology (March 16, 2023; https://www.dbrsmorningstar.com/research/410912).

Other methodologies referenced in this transaction are listed at the end of this press release.

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 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 [email protected].

The rating was initiated at the request of the rated entity.

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

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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

DBRS Limited
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Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

North American Single-Asset/Single-Borrower Ratings Methodology (February 23, 2023), https://www.dbrsmorningstar.com/research/410191

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022), https://www.dbrsmorningstar.com/research/402646

North American Commercial Mortgage Servicer Rankings (September 8, 2022), https://www.dbrsmorningstar.com/research/402499

Interest Rate Stresses for U.S. Structured Finance Transactions (August 30, 2022), https://www.dbrsmorningstar.com/research/402153

Legal Criteria for U.S. Structured Finance (December 7, 2022), https://www.dbrsmorningstar.com/research/407008

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