Since COVID-19 was officially declared a pandemic in March, all businesses have been dramatically affected, which was an obvious and direct blow to the commercial real estate industry.
Plunging treasury rates, some liquidity constraints, and global market uncertainty should have brought real estate transactions and subsequent defeasance volume to a halt, but it didn’t. Deals continue to push through, at industry volumes mirroring 2019, although transactions have felt different over the past six months with lenders, attorneys, and brokerage firms mostly working from home, physically away from their teams and normal systems. Some second-quarter deals in the pipeline ‘died’ or were put on hold indefinitely, while most others were merely delayed but still closed.
The ratio of pre-COVID defeasance closings were historically split evenly between sales and refinances.
Since March, that distribution had strongly tilted towards refinances, representing ~80% of our defeasance deal flow, as investor confidence plummeted and few price adjustments were given from Sellers even with the uncertainty associated with the pandemic; however, in the past few weeks, sales/dispositions have been starting to come back into our pipeline.
Multifamily transactions have steadily led defeasance volume over the past few years, and the COVID activity has pushed the multifamily dominance to over 70% of all current defeasances closed. If mobile home parks, industrial, and self-storage properties are included into these totals, the percentage increases to ~90% of all defeasance activity. Loan fundings from Freddie Mac and Fannie Mae have played an important role in driving multifamily volume by providing liquidity with historically low fixed interest rates, many of which are currently in the mid to high 2.00% range.
Logically, retail and hospitality transactions have been market laggards and most affected during this time; however, we continue to quote early exit scenarios for hotels and shopping centers. Only 7 Hospitality and 25 Retail properties were defeased since March, respectively, making up 1.5% and 5% of defeasance volume. Limited lender options, occupancy/tenant issues, and a battered outlook were key factors in the reduced volume.
In total, nearly 500 CMBS and Freddie Mac loans were defeased industry-wide from March through July.
While slightly surprising, that number was bolstered by many loans structured as portfolio-wide refinances with a single Sponsor; an example being the $2.4 Billion refinance of 67 multifamily properties for Southern Management Corp, which closed in May. Average defeasance costs that Borrowers paid during COVID were ~13% of the outstanding loan balance, representing average terms to maturity of less than 3 years and 4.45% average interest rates.
As the government stimulus packages and Payment Protection Program loans come to an end with no clear guidance for future government assistance, the CRE market could feel additional pain with lingering tenant issues, temporary halts for residential evictions, rent collection ambiguity, and maturing debt. Servicers and lenders continue to work through forbearance options, and sponsors are exploring all avenues for their troubled properties. These COVID times remain different than the 2008 financial crisis as CRE transactions continue to progress versus grinding to a halt. Short term investor confidence ebbs and flows with market volatility while the long term value of certain property types remain in balance with looming economic uncertainty. Our firm alone has been engaged in 75+ new defeasance transactions since July, giving us hope that the CRE industry will continue to fight through the pandemic.
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