Morningstar DBRS Confirms Credit Ratings on All Classes of AREIT 2022-CRE6 Ltd.

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by AREIT 2022-CRE6 Ltd. as follows:

-- Class A at AAA (sf)
-- Class A-S at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (sf)
-- Class E at BBB (low) (sf)
-- Class F at BB (low) (sf)
-- Class G at B (low) (sf)

All trends are Stable.

The credit rating confirmations reflect the overall stable performance of the transaction as borrowers are generally progressing through their respective business plans. Additionally, the transaction benefits from a concentration loans backed by of multifamily collateral, which has historically proven to better retain property value and cash flow when compared with other property types. As of the July 2024 reporting, 16 loans, representing 70.9% of the current trust balance, were secured by multifamily properties. In conjunction with this press release, Morningstar DBRS has published a Surveillance Performance Update report with in-depth analysis and credit metrics for the transaction as well as business plan updates on select loans. For access to this report, please click on the link under Related Documents below or contact us at [email protected].

As of the July 2024 remittance, the transaction has an outstanding balance of $785.5 million with 25 of the original 34 floating-rate loans remaining in the trust. There has been collateral reduction of 12.1% since issuance. An additional four loans with a former cumulative trust balance of $87.9 million have repaid since the previous Morningstar DBRS credit rating action in August 2023. Beyond the multifamily concentration noted above, there are two loans, representing 6.8% of the current trust balance, secured by office properties; two loans, representing 6.3% of the current trust balance, secured by hotel properties; and two loans, representing 6.3% of the current trust balance, secured by mixed-use properties.

The transaction is static with a 36-month Permitted Funded Companion Participation Acquisition Period, whereby the issuer can acquire funded loan participation interests into the trust through the January 2025 Payment Date. As of July 2024, the Permitted Funded Companion Participation Acquisition Account had a balance of $2.8 million.

Leverage across the pool has remained relatively unchanged since issuance as the current weighted-average (WA) as-is appraised value loan-to-value ratio (LTV) is 71.6% with a current WA stabilized LTV of 61.1%. In comparison, these figures were 71.7% and 64.5%, respectively, at issuance. Morningstar DBRS recognizes these values may be inflated as the individual property appraisals were completed in 2021 and do not reflect the current rising interest rate or widening capitalization rate environments. In the analysis for this review, Morningstar DBRS applied LTV adjustments to 13 loans, representing 63.6% of the current trust balance, generally reflective of higher cap rate assumptions as compared with the implied cap rates based on the appraisals.

As of July 2024, one loan, HGI Fremont Milpitas (Prospectus ID#11; 3.8% of the current trust balance), is delinquent and in special servicing. The loan transferred to special servicing in April 2024 for payment default and as of the July 2024 reporting, remains due for the January 2024 payment. According to the servicer, the borrower has requested relief and a loan modification, but no specifics with regard to the proposal or the status of negotiations have been provided to date. According to the servicer's analysis for the trailing 12-months ended March 31, 2024 period, the property generated minimal cash flow of $0.2 million with a debt service coverage ratio of (DSCR) of 0.19 times (x). The borrower's original business plan was to stabilize the collateral hotel's operations as the subject was recently constructed in 2021. At loan closing, the appraiser valued the property on an As-Is basis at $43.0 million, indicative of an LTV ratio of 69.3% based on the outstanding loan balance of $29.8 million. Given the current performance of the property and current status of the loan; however, Morningstar DBRS believes the current market value of the property has declined, with the borrower's initial equity in the transaction likely fully eroded. While there remains the possibility the borrower and the servicer will agree to a loan modification, Morningstar DBRS maintained a conservative approach with this review and liquidated the loan from the trust. Based on a significant haircut to the As-Is appraised value at issuance and estimated liquidation expenses, the scenario showed a loss severity in excess of 15.0%, which would be contained to the unrated $84.8 million first loss piece.

There are also 13 loans on the servicer's watchlist, representing 51.2% of the current trust balance. Most of the loans have been flagged for low occupancy rates and low DSCRs (trends that aren't unexpected considering most of the collateral remains in various stages of stabilization); however, all loans remain current. While Morningstar DBRS did expect initial property cash flow disruption as individual borrowers implemented their business plans, select loans have exhibited increased risks in stalled business plans and/or cash flow volatility beyond the issuance expectations. Additionally, increased debt service payments given the floating-rate nature of all loans in the transaction has placed greater stress on operating cash flows. Throughout 2024, 16 loans, representing 61.7% of the current trust balance have scheduled maturity dates. All 16 loans have extension options and if property performance does not qualify to exercise the related options, Morningstar DBRS expects the borrower and lender to negotiate mutually beneficial loan modifications to extend loans, which would likely include fresh sponsor equity to fund principal curtailments, fund carry reserves or purchase a new interest rate cap agreement.

Through May 2024, the lender had advanced $56.0 million in loan future funding to 19 of the outstanding individual borrowers to aid in property stabilization efforts, including $16.6 million advanced to 14 individual borrowers since the previous Morningstar DBRS rating action in August 2023. The largest advance to a single borrower ($5.3 million) has been made to the Balboa Retail Portfolio loan, which is secured by a portfolio of retail properties in Southern California (three properties, representing 58.5% of the original allocated loan balance) and Springfield, Oregon (one property, representing 41.5% of the original allocated loan balance). The borrower's business plan contemplated using up to $35.0 million of loan future funding to complete capital expenditure (capex) upgrades and fund leasing costs. Since August 2023, the lender has advanced $2.6 million of future funding and according to the collateral manager's Q2 2024 Quarterly Report, the property leased rates ranged from 75.1% (Shoppes at Gateway property in Springfield) to 100.0% (The Ranch property in Burbank, California).

Morningstar DBRS has yet to receive year-end 2023 financials; however, according to the quarterly report, the portfolio generated cash flow of $8.9 million with a 0.75x DSCR based on projected rental revenue from in place leases as of February 2024 and trailing 12-month expenses. In March 2024, the loan was modified to extend the future funding outside advance date by one year to January 2025 to allow the borrower additional time to complete capex projects and secure new tenants across the portfolio. There remains $21.7 million of loan future funding available to the borrower as $7.9 million of future funding originally allocated to the Lincoln Center property in Santa Monica, California, was reduced in conjunction with an expected property release. The majority of the dollars are expected to be needed at the Springfield property, as according to the quarterly update, a 119,555-square-foot former Sears anchor pad is expected to require a tenant allowance package of up to $150.00 per square foot or approximately $18.0 million.

In total, $32.3 million of future funding remains available to five individual borrowers. The largest amount, $21.7 million, is allocated to the borrower of the Balboa Retail Portfolio loan as noted above. The second largest amount, $3.8 million, is allocated to the borrower of the Villages at Canterfield loan, which is secured by a multifamily property in West Dundee, Illinois, and represents the largest loan in the pool, constituting 8.2% of the current trust balance. The borrower's original business plan, which contemplated using $6.2 million of loan future funding to renovate all 352 unit interiors and complete property-wide upgrades, appears to have stalled as only $2.3 million of future funding has been advanced since loan closing with no dollars advanced since August 2023. The loan was modified in December 2023 to waive the required property performance-based extension tests and to extend the renovation completion date to the fully extended loan maturity date of December 2025. According to the Q2 2024 collateral manager update, the borrower had completed 42.0% of its planned capex program with a focus on common area improvements, which have led to increased rental rates and tenant retention. As of May 2024, the property was 93.0% occupied with an average rental rate of $2,007 per unit, above the Morningstar DBRS stabilized rental rate assumption of $1,910 per unit. Morningstar DBRS has yet to receive YE2023 financials; however, given the generally healthy occupancy rate and the lack of delinquency or other signs the sponsor's commitment to the property and loan has diminished, the overall outlook remains stable.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective private rating letters at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

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 (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 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 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.

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

North American CMBS Multi-Borrower Rating Methodology (March 1, 2024)/North American CMBS Insight Model Version 1.2.0.0, https://dbrs.morningstar.com/research/428797

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://www.dbrsmorningstar.com/research/419592

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623/interest-rate-stresses-for-us-structured-finance-transactions

Legal Criteria for U.S. Structured Finance (April 15, 2024), https://dbrs.morningstar.com/research/431205/legal-criteria-for-us-structured-finance

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/410863.

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