Morningstar DBRS Removes All Classes of SG Commercial Mortgage Securities Trust 2020-COVE From Under Review With Negative Implications, Confirms Credit Ratings on All Classes

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on all classes of Commercial Mortgage Pass-Through Certificates, Series 2020-COVE issued by SG Commercial Mortgage Securities Trust 2020-COVE as follows:

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

The trends on Classes X, D, E, and F are Negative, and the trends on Classes A, B, and C are Stable.

With this review, Morningstar DBRS removed the credit ratings on all classes from Under Review with Negative Implications, where they were placed on September 5, 2024.

The underlying loan for this transaction is secured by a 283-unit Class A multifamily property in Marin County, California. Although the collateral benefits from a prime waterfront location, superior amenities, and limited competition within the submarket, the property's occupancy rate has lagged market levels for several years, with cash flows below issuance expectations as a result. Morningstar DBRS also notes the near-term maturity date in March 2025, which presents elevated refinance risk given the in-place cash flow declines. These factors support the Negative trends on the bottom classes. However, given the strong submarket fundamentals for multifamily properties and the collateral's high quality, Morningstar DBRS expects that there remains significant incentive for the sponsor to continue working to stabilize the property and either secure a maturity extension or contribute additional equity to secure a replacement loan. Those factors, as well as a value analysis suggesting that there remains significant cushion against loss for the upper part of the capital stack, support the credit rating confirmations and Stable trends with this review.

The transaction benefits from the collateral's premium quality and favorable position with the South Marin submarket, which offers a limited supply of multifamily properties given the lack of vacant land and environmental constraints on further development, resulting in a historically low vacancy rate. The sponsor, Maximus Real Estate Partners, has invested more than $50.0 million toward capital improvements since acquiring the property in 2013. The property is composed of 100 one-bedroom units, 138 two-bedroom units, 44 three-bedroom units, and one four-bedroom unit. Property amenities include a 52-slip boat marina, three pools, two spas, a playground, a clubhouse, and a fitness center.

The trust debt of $160.0 million is a pari passu participation interest in a $210.0 million whole loan, with the remaining balance represented by senior notes securitized in the BBCMS Mortgage Trust 2020-C7 transaction that is also rated by Morningstar DBRS. The loan is currently on the servicer's watchlist because of its pending maturity date. The servicer has reached out to the borrower for an update on the plans at maturity; however, as of the date of this press release, no updates have been provided to Morningstar DBRS.

According to the financial reporting for the trailing nine-month period ended September 30, 2024, the property generated $9.6 million of net cash flow (NCF) (annualized), reflecting a debt service coverage ratio (DSCR) of 1.22 times (x), a considerable decline from the issuance and Morningstar DBRS figures of $11.4 million (a DSCR of 1.43x) and $10.7 million (a DSCR of 1.31x), respectively. According to the September 2024 rent roll, the property was 86.6% occupied with an average base rental rate of $5,890 per unit ($5.80 per square foot (psf)). In comparison, the property was approximately 97.0% occupied (with an average base rental rate of $4,990 per unit) at issuance. Despite average in-place rental rates growing by approximately 20.0% since loan closing, increases in vacancy loss and operating expenses have driven declines in the NCF. As of September 2024, approximately 30% of three-bedroom units (which typically command the highest rental rates) and 11% of one-bedroom units were vacant. As a result, the sponsor continues to offer ongoing concessions while adjusting asking rents for those unit types downward to increase overall competitiveness and marketability.

According to Reis, similar vintage apartment properties within the South Marin submarket reported an average vacancy rate of below 5.0% with an average asking rental rate of $4,292 per unit. Likewise, a competitive set report provided by the servicer, which includes a select number of similar vintage/quality properties, reflects average occupancy rates of approximately 95.0% with an average rental rate $4.96 psf as of August 2024. Although the subject's average rental rate remains higher than that of the competitive set and submarket, the volatility in occupancy and reduced demand may be a result of the sponsor's pricing strategy, as opposed to the asset's overall desirability. As outlined above, it appears the sponsor has taken proactive steps toward bringing rental rates in line with the market average in an effort to stabilize operations at the property.

With this review, Morningstar DBRS considered a stabilized property value of $195.1 million, which is a variance of -5.0% and -31.6% from the Morningstar DBRS value and appraised value derived at issuance, respectively. Morningstar DBRS maintained the NCF derived at issuance of $10.7 million but elected to increase the capitalization rate to 5.5% from 5.25% to reflect the volatility in occupancy and cash flow, in addition to the execution risk tied to the sponsor's stabilization strategy. The updated Morningstar DBRS value implies a loan-to-value (LTV) ratio of 57.6% on the senior debt and an LTV of 107.7% based on the total mortgage debt amount of $210.0 million (compared with the LTV of 102.8% based on the Morningstar DBRS value at issuance). With this credit rating action, Morningstar DBRS removed the positive qualitative adjustment of 2.5% applied at issuance for low cash flow volatility and maintained positive qualitative adjustments to the LTV sizing benchmarks totaling 4.0% to account for generally strong property quality and stable market fundamentals.

The credit ratings assigned to Classes A, B, C, D, and E are higher than the results implied by the LTV sizing benchmarks by three or more notches. The variances are warranted given the subject property's premium quality; its favorable position within the South Marin submarket, which benefits from a historically low vacancy rate; and the generally positive leasing momentum evidenced over the last few reporting periods. However, Morningstar DBRS continues to be concerned about the elevated maturity risk in the short term, therefore supporting the Negative trends. Morningstar DBRS will continue to monitor this transaction for updates.

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 press releases 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 Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

Class X is an interest-only (IO) certificate that references 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 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 info-DBRS@morningstar.com.

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

DBRS Limited
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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 (September 19, 2024), https://dbrs.morningstar.com/research/439699
-- 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
-- Legal Criteria for U.S. Structured Finance (October 28, 2024), https://dbrs.morningstar.com/research/441840

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.

For more information on this credit or on this industry, visit https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.