What is CMBS? What are the delinquency rates of CMBS loans in each asset class? How does it differ from the 2008 rates, and what can investors do to prepare to take advantage of commercial real estate deals in the future. Jyoti Yadav, CMBS analyst at Trepp shares her insights.

Tell us a little bit about you.
I work as a research analyst with Trepp, which is a data analytics and modeling company based in New York. We track the CMBS, CRE and CLO data. We started in 1980s tracking the CMBS data, so we have information on loans and essentially the entire market since it started back then.

What is CMBS?
CMBS stands for commercial mortgage backed securities. It's essentially a financing vehicle to provide loans, or financing to commercial real estate property owners. This is not the only option available in the entire universe, CMBS accounts for 15 to 20% of the lending universe. It competes with insurance companies, banks and other financial institutions to provide loans to the commercial real estate industry. What happens in the market is that a bank, let's suppose entity A will provide, let's say, 10 loans to property owners across America, different property types, different geographic locations. That bank, if it has provided, let's say 100 million dollars worth of loans, will pull all of those loans together, that means the monthly mortgage payment that the borrowers are making to lenders. They'll pull all of that together and issue bonds which will be sold to investors.

So banks are able to offload the interest rate risks. They also have available capital which can be redeployed and lent to other commercial real estate property owners. That is why banks try to use this securitization methodology. Investors really like this investment because it's a 10 year fixed rate investment. In CMBS the borrowers have meaningful prepayment restrictions. That means that they cannot prepay a loan, and if they do prepay, they make additional payments to commensurate with the monthly payments they would have made otherwise. And investors get a diversified asset pool. It could be an office property in New York, it could be a hotel in Florida, Minnesota, Indiana. So it's a very diversified asset pool. And these are traditionally stabilized performing properties. You will see that all the loans that are there in the CMBS universe would have financial numbers going back a number of years since they were introduced in the market. You will know exactly who the tenants are, how long they are going to last, how big the property is, what's the square footage, what is the NOI per square foot, etc. So it really provides transparency in this market, which is otherwise not as transparent.

What is the current state of CMBS today?
Since COVID, whatever happened before March 2020, was a completely different story. The market was performing in a completely different way. And now after let's say late March, the situation has drastically changed. What is really happening is that there isn't as aggressive lending out there in the commercial real estate space. Lenders are extremely cautious. They want to really analyze the property. Let's suppose I am lending to office space in Houston, Texas. Before this crisis when oil prices were not that low, and the market was doing okay, they would look at the tenant roster, they would see who the tenants are and, most of the time there were no issues. Now in Texas, energy companies have been battered and the credit quality of the tenant has become an issue, you do not know if the current tenant of the property will continue its lease. You do not know if they will continue to make payments and that is really making lenders take a step back and understand who should they lend money to, and all sorts of analysis they need to do. Because of that, we have not really seen a lot of lending for hotels, of course, because hotels have suffered a lot and are still suffering a lot. So, there is a lot of hesitation in lending. And even when there is lending, there's a lot of analysis that's going on, and this also has increased the cost of borrowing for borrowers.

Because there is no lending, there is also no issuance in CMBS. We have seen very few deals come through, few new deals issued backed by different property types. And those deals also are priced much higher, spreads are much more for these deals. It's not as crazy as it was in April when no one had any idea how to price, everyone was being very conservative in their valuation. But most of these deals include loans which were made before COVID and banks were planning to announce these in March or April. But they had to be pushed out because at that point in time, there was a lot of hesitation in what sort of buying, what sort of investments people should make. And that what has happened in the last few months, in terms of new issuance of new loans. Now, one thing that Trepp does and we have been doing for a long time, is we put out analysis of performance of how the loans which are already in our universe are doing. What that means is we put out a statistic called the delinquency rate. And delinquency means that these borrowers are more than 30 days behind payment. And I want you to take a step back because the numbers that I'm going to give you are a little bit frightening.

I am sitting down.
Perfect, we definitely need that. I have interacted with number of people who have been around during the last financial crisis and even when they see the numbers and how fast things have completely upended, we take a step back, we really prepared ourselves.

How are the different asset classes doing, the different property types performing in the CMBS world?
Let me start with an overall number. The June delinquency report that we published had a delinquency rate of 10.32%. To give you a background Trepp tracks approximately over half a trillion dollars worth of loans. And that's approximately more than 200,000 loans that we track. So a 10% delinquency rate means that more than $50 billion worth of loans are behind on their payment, and there is distress in the sector. So on an overall basis, that's the number. Now if we compare it to an earlier crisis, in the last financial crisis, the number was 10.34%. So we are fairly close to the peak that we have ever seen.

How long did it take to get to this 10% in 2008 because we are just four or five months into COVID?
Exactly. And that's a very good point because in the last financial crisis, the number that I quoted, 10.34%, was in July 2012. The crisis started in 2007/2008, so it took some time for us to reach that number. In the current crisis, the number was approximately 2% before this crisis really came, and no one knew exactly how to understand it. Until April 2020, that number was 2.29%. And now in June, it's about 10%. So it was a very fast increase. If you're ready, I can also get into the property types.

I will give the bad news first so that's out of the way. As far as hotels, I have not taken a vacation this summer. I don't know any of my friends or family who have. And I have heard from a number of my colleagues who haven't, this is telling us how tourism is essentially decimated as an industry. People are not taking vacations, they're not going out. They're not booking hotels, and that has reduced the occupancy rate at hotels. And that has increased the delinquency number from approximately 1.5% earlier in the year to almost 25% in June. So it's almost $20 billion worth of loans that are behind in their payments. I do want to talk a little bit about what I know about July based on our numbers right now, but this is your number.

Similarly in retail, retail is industry which was already seeing a lot of distress just because we all shop online now. So it was seeing an increase in delinquency rate, but it was slowly, people who had made big short bets against malls, but expecting that retail will go downhill maybe in 2022, 2023. But now, the delinquency rate again has risen from below 4% earlier in the year to 18%. And that is approximately $23 billion worth of loans which are behind. Those are the really crazy numbers. Retail and lodging are seeing a lot of distress.

Moving on to okay news, multifamily is not really seeing that much impact. Of course it is because of the stimulus checks, the government programs, moratorium on evictions, and there is a backstop there. So we have not seen a lot of distress in that sector.

Office on the other hand, is something that we are watching very closely. You're working from home, I'm working from home and companies working from home. We're getting used to this, we are productive, we are able to put out the kind of work we would have almost done if we were in office. So there is a change in preference and we want to see what it will really do to the market. Right now we are not seen that much distress in the office asset class.

The good part in all of this data is the industrial sector. The CMBS industrial sector market is not very big, but we are still seeing some positive news there. It was the only sector which actually saw a reduction in delinquency rate. That means that more and more people are making timely payments because of the ecommerce, because they are setting up warehouses and distribution centers. I've just read in a recent Wall Street Journal article talking about how retail in brick and mortar stores are being converted to distribution centers. So the overall macro trend is visible in our data set as well. That is an overall idea of how the sector is performing.

Given that this delinquency rate took four years in the last downturn and for the exact same delinquency rate to take four months in this downturn, what do you think will happen in the next six months to a year with commercial real estate properties?
In terms of the nature of the two crises, they're very different. The last one was about loose underwriting standards, losing confidence in the financial market, but even then, there was still demand and the consumer demand did not completely die down. Yes, there was significant impact, but that did not die down. And what happened in this crisis is that there is a complete demand shock in terms of shutdown of industries, which depended on our old way of living: entertainment, movie theaters, airlines, those industries are just completely gone. And so are the businesses that revolve around that. Kids are not going back to school. What happens to student housing, what happens to small retail stores set up around that neighborhood? People are not flying, what happens to tourism related economies, their hotels, their retail sector? And the same with office space.

We can also talk about the geographical location, how things are very different in different areas. In terms of New York, there was a lot of business travel, there was a lot of tourism, there was a lot of entertainment. And all of that was essentially shut down for the last four months. Just to add a point there. This is my personal belief, but I'm a strong believer in New York strong. And I think New York will come back. But in the meantime, these past four months have created a lot of distress in the sector. So overall, what we see right now is that this crisis is going to have a long tail, it is not going to bounce back right away. Things are going to trickle down for a long period of time. And in some ways, it's likely that it will be worse than the last crisis, I don't mean to frighten you there, but that's what I'll end with.

What can investors do to prepare to take advantage of commercial real estate deals in the future?
There are a lot of distressed assets out there. We have received requests from a number of clients, distressed asset buyers, investors who are looking to invest in the market. I would say that investors have to look at macro level data in terms of how the economy is doing, what the unemployment statistics are, how the manufacturing is going. And they also have to look at the micro level granular data. For example, investors would want to look at where is the highest delinquency rate. Which property type is seeing the highest delinquency rate and in which geographical region, San Francisco as a matter of fact does not have a very high delinquency rate. Whereas New York right now does. And upstate New York on some level is even higher, there are a few malls here and there, but it is a high delinquency rate. So that is an overall statistic. You want to look at the occupancy rate trends. If you are trying to zero down on a hotel investment, you want to see what has been the hotel revenue for the past three years, what was the occupancy rate there? What was the performance, what were the revenues for the last few years and then really put yours on. You need very different kind of assumptions that you have to factor in and a very different kind of analysis to understand how you can zero down on investments right now. But that's possible. It just comes down to doing a very thorough analysis, digging deep into every property, every loan that you want to look at, getting your hands dirty and figuring out where you can find those investments.

Knowing what we know today, which is we have no idea when this will be over. How many months of reserves, or years of reserves, would you recommend an investor having at this point in time, if they were to come across a distressed deal that looks very interesting when the economy comes back to normal?
That's a very good question, actually. I want to get into that question with a slight digression. Right now, we have a different statistic in our database regarding loans, which is tracking if a property owner has requested a forbearance. And the forbearance is a deferral of payment for approximately three months for most of the borrowers. Some hotel owners have requested in April, some have requested in June, starting three months from there. What they are doing during these three months is they're actually using their reserve account to service their debt. We are seeing that those reserve accounts are already going significantly down, and those are being utilized to make these payments. So it is very dependent on what kind of property you are looking at. Are you looking at a Class A mall, or are you looking at a Class B or C mall or some of the malls that were owned by CBL REIT, which is trying to file bankruptcy soon, according to a news article, so it's very property specific, but there are properties out there, which are doing much better compared to some others who are completely battered and are ready to give back their keys. Some of them need financing in the next few months. Some of them need financing in six months, you really have to figure out which ones are not going to be able to make it.

Is there anything else that our listeners should know?
I'll cover what we are seeing in July 2020 right now. I talked about the June numbers earlier, as of now, we have approximately 80% of the data. What we are seeing right now is actually that the delinquency rate has reduced from June. That's good news. Although I would like to warn everyone who's listening that, again, this goes back to me emphasizing the fact that you really have to get into the data. The reason why I'm saying that is that we have seen loans that have received forbearance supplement, that's why they're not delinquent anymore. The forbearance agreement could be for three months, six months, some have it even longer going all the way somewhere into 2021. So the delinquency rate could be low because of that very reason.

You have to dig in and see why that number has reduced, and does that mean that we will see an uptick maybe three months down the line? To give an example on the last point that I just made, Queens Center Mall in New York has a $600 million loan, they have received a forbearance agreement for a certain amount of time. Similarly, there is a $430 million loan in Syracuse, New York, Destiny Mall, which has also received an extension. At the same time, Mall of America in Bloomington, Minnesota, which has a $1.4 billion loan, and they are 90 days behind payment. And these are just the big statistics that I'm putting out there where you can see their expenses, you can see how their revenues are completely decimated. It is very dependent on where the property is located and how it has performed in the current time. I would like to give more and more information as it becomes available in order to help understand what the bigger overall number means in terms of data.

Jyoti Yadav