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

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of 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 stable performance of the collateral, which has remained consistent with Morningstar DBRS’ 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 (IO) payments for three years and has a conditional performance test determinant of amortization for its fourth year. If the following conditions are met at the beginning of year four (July 2024), then the loan will continue on an IO basis. The performance criteria include benchmarks of a 70.0% occupancy rate for three consecutive months prior to the test and an 8.0% debt yield based on a trailing three-month reported financial statement. The loan-to-value (LTV) ratio requirement is 60% or lower based on a new appraisal. However, given that the loan does not yet meet these requirements, Morningstar DBRS believes it is likely the loan will begin amortization on a 25-year amortization schedule. The loan has an initial maturity in July 2025, and is structured with two 12-month extension options, which are also subject to performance criteria.

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, was to 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 renovations were initially budgeted at $30.9 million and are to 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.

At issuance, the sponsor’s ultimate goal for the subject was 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 collateral manager, Phase I has been completed and the borrower is currently working on Phase II. Through February 2024, $8.1 million (30.0%) of the future funding has been advanced to the borrower as the current funded A note balance is $69.1 million. The remaining available dollars for capital expenditure and tenant leasing costs are $13.0 million and $6.6 million, respectively. It was also noted that the most recent budget for this project is $53.2 million, with the additional scope and costs to be funded entirely out of pocket. The borrower anticipates receiving $4.4 million in historic tax credits, reducing the net budget amount to $48.8 million. The increased scope in work is to improve access to the buildings and the increase in costs is attributed to the intensive work and higher cost than initial estimates. Morningstar DBRS requested further details on whether the execution of this project will delay the timeline for the completion of the current business plan; however, an update was not provided by the collateral manager by the date of this writing. Morningstar DBRS credits this recent development as a positive consideration in its analysis as it strengthens the sponsor’s commitment to the property.

According to the most recent reporting, the collateral was 50.3% occupied as of June 2023 compared with 66.0% occupied at issuance. 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 YE2023 vacancy rate of 6.7% with an average five-year vacancy rate of 7.5%, while office properties reported a YE2023 vacancy rate of 23.6% with an average five-year forecast vacancy rate of 21.2%. Morningstar DBRS 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, Morningstar DBRS 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. Morningstar DBRS analyzed the 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 Morningstar DBRS 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. Morningstar DBRS 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, 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 Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

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 1, 2024), https://dbrs.morningstar.com/research/428798.

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

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

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 (March 1, 2024), https://dbrs.morningstar.com/research/428799

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

A description of how Morningstar DBRS analyzes structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/417279. (July 17, 2023)

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