The recent property acquisitions reported over the last two weeks are signs that the U.K. commercial property investment market may be headed towards revitalization. However, while these tentative signs are a credit positive for CMBS, the individual credits may be affected differently if “share deal” structures are used, Moody’s Investors Service analysts said.
Traditionally, investors purchase a property outright, which implies that the seller prepays the existing debt secured by this property. “Share deals” are an alternative wherein the investor acquires the property by purchasing the equity interest in the property holding company.
The property is purchased with debt attached. Blackstone Group’s purchase of a 50% share of the City of London office complex Broadgate is an example. Blackstone bought half of the equity interest and took on as a borrower half of the debt secured against the estate. The debt is securitized in the Broadgate Financing plc CMBS transaction.
“A share deal structure is beneficial for the new investor as it allows for the acquisition of properties with a relative low equity outlay,” Moody’s analysts said. “The investor also receives more debt financing, and often on more favorable terms regarding pricing and flexibility than if the property was bought outright and refinanced.”
Share deals can have a number of implications for a CMBS transaction. For example, the change to the ownership structure of the equity interest could trigger a default resulting from the “change of control” clauses in the loan agreement. A share deal can also be combined with a partial loan prepayment.
Moody’s analysts said that the impact on particular CMBS transaction notes that include the affected loan is less clear-cut.
“For example, while the average credit quality of the securitized pool would typically improve, it can split the portfolio in terms of loan quality," analysts said. “This is because share deals will often happen for the better loans in the CMBS pool, resulting in these loans potentially partially prepaying while worse loans remain fully outstanding.”
Such “adverse selection” can be mitigated if prepayment proceeds are allocated sequentially to the more senior CMBS notes, but many transactions apply such proceeds (modified) pro-rata or even reverse sequentially. As a result, partial prepayments from share deals could have a negative impact on the credit characteristics of senior CMBS classes.