Morningstar DBRS Places North American Single-Asset/Single Borrower Transactions Backed by Office Properties Under Review With Negative Implications

DBRS, Inc. (Morningstar DBRS) placed outstanding public credit ratings associated with 82 North American single-asset/single-borrower (NA SASB) transactions backed by commercial real estate (CRE) loans primarily secured by office collateral types Under Review with Negative Implications and removed the existing trends on the ratings, as credit ratings placed under review do not carry trends. These NA SASB transactions were issued between 2013 and 2023, with just under half (37) issued between 2020 and 2023. In addition, Morningstar DBRS placed outstanding public credit ratings on six rake bonds associated with multi-borrower transactions issued between 2014 and 2020, each of which are also backed by loans collateralized by office properties, Under Review with Negative Implications and removed the trends on the ratings. All of the credit ratings Morningstar DBRS placed Under Review with Negative Implications are determined and monitored using the LTV Sizing Benchmarks as described in the “North American Single-Asset/Single-Borrower Ratings Methodology” (the NA SASB Methodology).

Morningstar DBRS decided to place these credit ratings Under Review with Negative Implications to undertake a review of the NA SASB office-related loans as the office market dynamics may have shifted, prompting a review of the Morningstar DBRS Values and, by extension, the Morningstar DBRS Capitalization (Cap) Rates assigned to determine that those values are reflective of the change in the office sector’s forward-looking credit outlook. The change in the outlook on office is a result of the overall stress observed over the last few years for office property types across the country, as a significantly higher interest rate environment has coincided with shifting office use dynamics following the increase in remote work amid the coronavirus pandemic. These dynamics have resulted in lower investor appetite for office property types, which has, along with higher interest rates, contributed to higher cap rates for the relatively few sales that have occurred since the beginning of 2022. These same factors have also contributed to increased defaults on office loans in commercial mortgage-backed securities (CMBS) and other CRE finance sectors over the last year.

Morningstar DBRS’ credit ratings for six publicly rated NA SASB transactions have recently been addressed to reflect event-driven stress such as term and/or maturity defaults, significant performance declines, and tenancy issues. As the credit ratings for those transactions were deemed to currently reflect those and the market-driven stresses in the most recent analytical approaches, they were excluded from this Under Review with Negative Implications action.

The NA SASB Methodology outlines the approach for arriving at a Morningstar DBRS Value for the collateral properties securing the loans typically backing an NA SASB transaction. A Morningstar DBRS Net Cash Flow is derived and a Morningstar DBRS Cap Rate is applied, with a Morningstar DBRS Cap Rate range for office property types of 6.0% to 10.0%. As part of the review process for this credit rating action, Morningstar DBRS will evaluate the Morningstar DBRS Cap Rates applied in the valuation approach for each transaction to determine the need (if any) for further stress given the increased volatility for the property type as described above.

For the 82 NA SASB transactions affected by this credit rating action, the Morningstar DBRS Cap Rates at issuance ranged between 6.0% and 8.75%, with an average of 6.85%. Approximately 50 of the 82 transactions are secured by collateral properties in major markets within New York or California. According to CBRE’s H1 2023 Cap Rate Survey, cap rates for stabilized office properties in New York City ranged between 5.5% and 6.25% for H1 2023 (up from 5.5% to 6.0% in H1 2022). The same report showed that cap rates for stabilized office properties in Los Angeles and San Francisco ranged between 7.0% and 7.5% and 6.5% and 7.5%, respectively; these figures compare with the H1 2022 ranges of 6.25% and 7.0% for Los Angeles and 6.0% and 6.75% for San Francisco.

As these transactions are reviewed, Morningstar DBRS will consider factors including the collateral building quality, the location, respective market dynamics, in-place tenancy, and others to evaluate the Morningstar DBRS Cap Rate and other analytical considerations used to determine the credit rating. Morningstar DBRS typically resolves an Under Review action within 90 days but notes the review period for some transactions may take longer as the timeline for gathering information could be disrupted as market conditions and collateral-specific dynamics continue to evolve.

For more information on Morningstar DBRS’ outlook for the North American office sector, please see its commentary entitled “Differentiating North American Office Properties Amid Sector-Specific Pressures.”

Morningstar DBRS notes that this press release was amended on January 23, 2024, to add five NA SASB transactions and two rake bonds associated with multi-borrower transactions to the list of affected transactions, as follows:
-- 1166 Alberni Street
-- Albert & Lyon Equities Inc., Albert & Lyon Properties LP and Canderel CSQ Ottawa LP - Constitution Square
-- ASQ Building
-- DC Office Trust 2019-MTC
-- LIFE 2021-BMR Mortgage Trust
-- Benchmark 2021-B25 Mortgage Trust Amazon Seattle Loan-Specific Certificates
-- BMO 2022-C1 Mortgage Trust 360 Rosemary Loan-Specific Certificates

The change was minor and would not affect the understanding of the reader.

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023) at https://dbrs.morningstar.com/research/416784.

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

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

The principal methodology is North American CMBS Surveillance Methodology (March 16, 2023; https://dbrs.morningstar.com/research/410912).

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

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

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

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

This is a solicited credit rating.

Please note a sensitivity analysis was not conducted as it is not applicable for an Under Review with Negative Implications action.

These credit ratings are Under Review with Negative Implications. Generally, the conditions that lead to the assignment of reviews are resolved within a 90-day period. However, as previously noted, there are factors that could contribute to an extended review period for some transactions included in this action.

DBRS, Inc.
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Chicago, IL 60602 USA
Tel. +1 312 332-3429

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

-- North American Single-Asset/Single-Borrower Ratings Methodology (October 19, 2023;
https://dbrs.morningstar.com/research/422174)

-- Rating North American CMBS Interest-Only Certificates (December 13, 2023; https://dbrs.morningstar.com/research/425261)

-- Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023; https://dbrs.morningstar.com/research/415687)

-- DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023; https://dbrs.morningstar.com/research/420982)

-- North American Commercial Mortgage Servicer Rankings (August 23, 2023; https://dbrs.morningstar.com/research/419592)

-- Legal Criteria for U.S. Structured Finance (December 7, 2023; https://dbrs.morningstar.com/research/425081)

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