Morningstar DBRS Confirms Credit Ratings on All Classes of ACREC 2023-FL2 LLC

DBRS, Inc. (Morningstar DBRS) confirmed its credit ratings on all classes of notes issued by ACREC 2023-FL2 LLC (the Issuer) as follows:

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

All trends are Stable.

The credit rating confirmations reflect the overall stable performance of the transaction. The transaction is fully composed of loans backed by multifamily properties, a property type which has historically shown more resiliency in terms of maintaining property value and cash flow compared with other property types. Morningstar DBRS determined that most of the individual borrowers are progressing with their respective business plans to increase property cash flow and value. For loans exhibiting increased execution and other risks, Morningstar DBRS applied stressed scenarios in the analysis for this review, including elevated loan-to-value ratios (LTVs) based on higher capitalization rates (cap rates) as compared with the implied cap rates based on the issuance appraisals and the issuance or in-place cash flows. This analysis resulted in higher expected losses (ELs) for those loans and increased the weighted average (WA) EL for the overall pool as compared with the WA pool EL at the previous Morningstar DBRS credit rating action in November 2023. The transaction's significant cushion in non-rated and below investment grade rated proceeds of nearly $100.0 million provides significant support; however, limiting the overall impact of the increase in the pool EL, with the credit rating confirmations supported.

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].

The initial collateral consisted of 15 floating-rate mortgage loans secured by 18 mostly transitional properties with a cut-off balance totaling $534.2 million. Most loans were in a period of transition with plans to stabilize the performance and improve the values of the underlying assets. As of the October 2024 remittance, 13 loans secured by 16 properties, with a current cumulative trust balance of $491.9 million, remain in the transaction as two loans, with a cumulative former trust balance of $64.3 million, have been paid in full since the previous Morningstar DBRS credit rating action. The transaction is static with a two-year Replenishment Period, whereby the Issuer can purchase funded loan participation interests into the trust. The Replenishment Period is scheduled to end with the February 2025 Payment Date. As of October 2024, the Replenishment Account had a balance of $42.1 million.

Leverage across the pool remains similar to issuance metrics with a current weighted-average (WA) as-is appraised loan-to-value ratio (LTV) of 73.3% and a current WA as-stabilized LTV of 64.0%. At issuance, these metrics were 73.0% and 64.0%, respectively. Morningstar DBRS recognizes that select property values may be inflated as the majority of the individual property appraisals were completed in 2021 and 2022 and may not reflect the rise in interest rates and cap rates since that time. As such, in the analysis for this review, Morningstar DBRS applied upward LTV adjustments across 12 loans, representing 92.2% of the current trust balance.

Through November 2024, the lender had advanced cumulative loan future funding of $27.8 million to nine of the outstanding individual borrowers since their respective loan closings to aid in property stabilization efforts. This includes $5.1 million in cumulative advances to seven individual borrowers since November 2023. The largest cumulative advance ($6.3 million) to a single borrower since loan closing was made to the borrower of the Brandon Portfolio loan, which is secured by a portfolio of two multifamily properties totaling 285 units in Brandon, Florida.. The borrower's business plan is to complete a significant capital expenditure (capex) project totaling $7.3 million across the portfolio and to operate the individual properties as one asset. The borrower appears to be progressing with its capex plan, as according to the collateral manager's Q2 2024 Quarterly Asset Review report, the borrower had completed the property amenity and exterior upgrades as well as interior upgrades to 172 units, up from 110 unit upgrades as of Q2 2023. The property had an occupancy rate of 95.4% with an average rental rate of $1,593 per unit as of September 2024, which compares favorably with the September 2023 figures of 87.0% and $1,588 per unit, respectively. The collateral manager has reported that renovated and rented units achieved a monthly rental rate premium of approximately $450 per unit, above the targeted premium of $300 per unit. The net cash flow (NCF) of $2.6 million for the trailing 12 months (T-12) ended September 30, 2024, was less than both the original Morningstar DBRS stabilized NCF of $3.0 million and the original issuer stabilized NCF of $4.3 million. An additional $1.0 million of loan future funding remains available to the borrower; however, loan maturity is upcoming in January 2025. According to the collateral manager, the borrower is expected to exercise the first of up to two 12-month extension options.

An additional $10.3 million allocated to six individual borrowers remains available. The largest portion ($3.8 million) is allocated to the borrower of the Galleria Courtyards loan, which is secured by a multifamily property in Smyrna, Georgia. Total loan future funding of $8.4 million was available to the borrower at loan closing to complete its capex plan, which consists of upgrading all 240 unit interiors and property exteriors. Since November 2023, the lender advanced an additional $0.7 million to the borrower to continue to implement its business plan, however, it appears the borrower remains behind in its business plan execution. According to the Q2 2024 update from the collateral manager, 137 unit upgrades had been completed to date, an increase from the 96 unit upgrades completed as of Q2 2023. As of the September 2024 rent roll, the property was 89.6% occupied with an average rental rate of $1,593 per unit. In comparison, these figures were 88.8% and $1,698 per unit, respectively, as of October 2023. Reportedly, renovated and rented units achieved a monthly rental rate premium of approximately $500 per unit, above the targeted premium of $300 per unit. The NCF of $2.5 million or the T-12 ended September 30, 2024, equals the original Morningstar DBRS stabilized NCF of $2.5 million but is less than the original issuer stabilized NCF of $3.0 million. The loan also matures in in January 2025, and according to the collateral manager, the borrower is expected to exercise the first of up to two 12-month extension options.

Including the Brandon Portfolio and Galleria Courtyard loans, seven loans, representing 47.9% of the current trust balance, are scheduled to mature in the next six months. According to the collateral manager, six borrowers are expected to exercise available extension options, which will require them to purchase replacement interest rate cap agreements and to rebalance the loans if property performance does not meet required minimum thresholds. The remaining loan, Millennia NC Portfolio (Prospectus ID#14; 5.6% of the current trust balance), is secured by a portfolio of three multifamily properties in the greater Raleigh-Durham, North Carolina area. While an outstanding extension option is available to the borrower, the collateral manager has not received notification regarding the borrower's plan for the March 2025 maturity date. According to the October 2024 reporting, the loan is less than 30 days delinquent. The stabilization efforts have stalled as the borrower has struggled to complete capex across the portfolio and increase rental rates because of issues related to collection loss. In its analysis of the loan, Morningstar DBRS applied upward as-is and as-stabilized LTV adjustments to the loan, which resulted in a loan EL above the WA EL for the overall pool.

As of the October 2024 reporting, no loans are specially serviced nor are there any loans on the servicer's watchlist. According to the collateral manager, loan modifications have been executed with four borrowers, representing 32.5% of the current trust balance, that have allowed the borrowers to extend maturity dates or to access existing reserve accounts. The Accent Edgewood loan (Prospectus ID#2; 7.6% of the current pool balance) was modified at loan maturity in May 2024 to allow the borrower to extend the loan to May 2025 with one additional 12-month extension option. In exchange, the borrower paid the loan down by $6.0 million and purchased a new interest rate cap agreement.

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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

Classes D-X and E-X 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.

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.

Notes:
All figures are in US 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 (September 19, 2024), https://dbrs.morningstar.com/research/439702

North American Commercial Mortgage Servicer Rankings (August 23, 2024), https://dbrs.morningstar.com/research/438283

Interest Rate Stresses for U.S. Structured Finance Transactions (February 26, 2024), https://dbrs.morningstar.com/research/428623

Legal Criteria for U.S. Structured Finance (October 28, 2024), https://dbrs.morningstar.com/research/441840

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

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].