The recent transfers to special servicing on CMBS large loans have demonstrated the default risk from near-term tenant rollovers, according to Barclays Capital in a report released Wednesday.
The issue is specially significant because the broader commercial real estate fundamentals are still in the early stages of recovery.
Considering this, tenants that are up for renewal in the near term will still reset at lower rents. Some tenants will also view upcoming lease expirations as their chance to lessen their leased area to be in line with their new workforce population/economic situation. This can impact property net operating incomes and cause a transfer to special servicing, Barclays said.
The factors that drive a loan into default have shifted in the last three years, analysts from the bank said. Most special servicing transfers in the 2008-2009 cycle were caused by weak, proforma underwriting or tenant/borrower bankruptcy. Their share of monthly transfers has dropped since then.
By contrast, the percentage of lease rollover-related defaults has been rising. Barclays analysts projected that over 35% of special servicer transfers in 2012 resulted from large lease expirations. This increased from 10% in 2008.
A rollover default is caused by tenant behavior instead of the loan's underlying leverage or characteristics. Given this, a conservatively underwritten loan that has stayed current through the downcycle can still turn around and default if it faces considerable lease expirations in the near term and a big tenant leaves, analysts explained.
The usual NOI-index based models that do not consider lease rollover schedules can thus underestimate the future default risk for currently performing loans, they said.
Analysts estimated that loans experiencing over 10% of near-term lease rollover are three times more likely to default versus loans where less than 5% of underlying leases are expiring.
The risk is further increases if the loan shows current LTV>100. An underwater borrower with tenants resetting at lower rents per area will lean more toward either walking away from the property or pushing the loan into special servicing or otherwise requesting a modification, analysts said.
Lease expiration schedules apper steady for the coming years, Barclays stated. Based on the observed probability of default, analysts projected roughly $15 billion of currently performing loans will transition to special servicing in the next year because of tenant rolls.
The risk should decrease after 2014-2015, by which time occupancy and rents should have recovered by a lot. At that juncture, the tenants will have less reason to cut back and borrowers can then quickly re-tenant the vacant space in their properties, Barclays said.