Morningstar DBRS Confirms Credit Rating on the Mortgage Loan Secured by ASQ Building with Stable Trend, Removes Credit Rating From Under Review With Negative Implications

DBRS Limited (Morningstar DBRS) confirmed the credit rating of BBB (of) with a Stable trend to the Mortgage Loan Secured by ASQ Building. The credit ratings have been removed from Under Review with Negative Implications where they had been placed on April 15, 2024, as part of Morningstar DBRS' review of transactions secured by office properties within its North American Commercial Mortgage Backed Securities Single-Asset/Single-Borrower (NA CMBS SASB) portfolio. The review was prompted by Morningstar DBRS' view that a shift in the use and demand for office space has been observed in the last few years. Amid the increase in remote work and hybrid schedules, tenant demand in urban markets, such as those most frequently represented in the NA CMBS SASB space, has been the most resilient for those higher-quality buildings that offer extensive amenity packages and are located close to transportation hubs with other nearby draws for commuters and city dwellers alike. These trends are expected to be sustained in the long term and their ripple effects of increased tenant improvement costs, capital improvement expectations, and decreased demand for some markets and neighborhoods will continue to influence investment activity for the office sector as a whole. For more information regarding the approach and analysis conducted, please refer to the press release titled "Morningstar DBRS Takes Rating Actions on North American Single-Asset/Single-Borrower Transactions Backed by Office Properties," published on April 15, 2024.

At the conclusion of the April 2024 review, several transactions, including the subject transaction, remained Under Review with Negative Implications. This generally reflected the existence of evolving factors for those credits for which Morningstar DBRS identified a need for more information to be gathered to inform the analysis. With this review of the subject transaction, Morningstar DBRS has resolved the Under Review with Negative Implications status. The full details of the credit rating actions and ratings rationale are outlined below.

The Mortgage Loan, which has an outstanding balance of $46.8 million as of July 2023 is scheduled to mature on August 1, 2030, and is secured by the ASQ Building, a 230,471 square feet 14-storey Class B office property with a two-story podium, located approximately 10 kilometers south of downtown Vancouver. The credit rating reflects the cash flow stability provided by the in-place rental income combined with the property's location within the desirable Downtown Vancouver office submarket where the current market vacancy rate for Class B office space is 12.9%, according to CBRE Research's Q1 2024 Vancouver Office figures. The property was built in 1975, and has historically reported occupancy rates in excess of 90.0%. Based on review of the most recent leasing data, Morningstar DBRS concluded that the majority of tenants with leasing expiring have renewed or space has been backfilled, as market sources report approximately 15.0% of net rentable area available.

Given the shift in the use and demand for office space has been observed in the last few years, an updated Morningstar DBRS value was derived, with an evaluation of the capitalization (cap) rates and the performance of property cash flows relative to the Morningstar DBRS net cash flow (NCF) that was derived in 2020. In addition, any qualitative adjustments applied in the analysis to account for property quality, market fundamentals and/or cash flow stability, were also assessed. Where market conditions are expected to remain the most stressed compared with pre-pandemic levels, the qualitative adjustments for market fundamentals were typically moved downward to reduce the benefit in the loan-to-value (LTV) sizing.

Morningstar DBRS had previously concluded to a value of $59.1 million for the subject property (LTV of 79.6%), which was based on the Morningstar DBRS NCF of $4.3 million and a cap rate of 7.25%. With this review, Morningstar DBRS increased the cap rate to 7.5%, resulting in an updated Morningstar DBRS value of $57.2 million (LTV of 79.6%). Morningstar DBRS decreased the market fundamentals from 5.0% to 2.75% as the Canadian office markets look to be in better shape than those in the U.S. In addition, Morningstar DBRS maintained the property quality and cash flow volatility at 3.0% and 0.0%, respectively. Although the resulting LTV Sizing Benchmarks suggested nonmaterial downward pressure for the mortgage loan, the credit profile of the transaction remains in line with Morningstar DBRS' expectations.

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 at (January 23, 2024), 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 Canadian 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)
Morningstar DBRS North American Commercial Real Estate Property Analysis Criteria (June 28, 2024; https://dbrs.morningstar.com/research/435293)
North American Commercial Mortgage Servicer Rankings (August 23, 2023; https://dbrs.morningstar.com/research/419592)
Legal Criteria for Canadian Structured Finance (June 20, 2023; https://dbrs.morningstar.com/research/416101)
A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863. (July 17, 2023)

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