By Karsang Sherpa Vice President
Caldera Asset Management, Denver
ksherpa@calderaassetmanagement.com

The Apartment CMBS delinquency rate in July 2009 hit 5.71%, a 289 basis points jump from 2.82% recorded in December 2008 and 404 basis points jump from only a year ago. At 5.71%, the current rate looks alarming, but even more alarming is the speed at which it is spiraling up

Source: Trepp

Per Trepp data, over 24% of all apartment CMBS loans are on the “Watchlist”. A detailed analysis of "Watchlist" loans tell a story of large possible defaults that may hit virtually all metropolitan areas and spread across all asset classes, including Class A, B and C. Loans are put on Watchlist based on standards developed by Commercial Mortgage Securities Association (CMSA). There are 12 possible criteria including quantitative factors such as debt service coverage ratio (DSCR), loan to value ratio (LTV), net operating income cashflow (NOI and NCF), performance trend of the asset and months to loan maturity, and qualitative factors such as management expertise, deferred maintenance work and market condition.

Nationwide, a staggering $24 billion CMBS loans are on Watchlist. What is more surprising is even historically stable institutional cities such as Washington D.C. and San Francisco make to the top ten list. Even in these cities, transactions done between 2005 and 2007, and based on ever increasing rents and decreasing cap rates have suffered when those assumptions didn’t materialize.
Source: Trepp

Although the nationwide weighted average Watchlist is over 24%, the median falls around 20%. Since Dallas has 21% loans on Watchlist, and its loan amount is over $1 Billion, a detailed analysis of the largest 200 Watchlist loans in Dallas helps to provide a picture that is consistent across most of the MSA’s. 55% of Watchlist loans were originated between 2005 and late 2007, and even at a weighted average interest rate of only 5.77% today, almost 35% of these 2005-2007 vintage loans have less than 1 DSCR based on net income. One-third of these loans also face short-term interest rate risks since they have floating rates based off Libor.

Vitually all the Watchist loans originated prior to 2005 were set at fixed rates with a weighted average rate of 6.53%, and about half of these have lower than 1.0 DSCR based on net income. Among all 200 loans, only 10% are maturing in 2009 and 2010, clearly signaling that majority of loans are facing term risks.

One potential exit out of this problem would have been an increase in revenue from the assets. Unfortunately, per most of the economic research and projections, net demand in number of apartment units is not projected to hit positive territory until 2011, rent will continue to decline until late 2010 and vacancy will continue to inch upward and hit 10% in 2010 before slowly contracting to 7% in 2013. Therefore, revenues are not projected to stop the current decline until late 2010, and it will be a long while before the increases on the rents will actually make up for all the declines. This means assets that were purchased at negative arbitrage between 2005 and 2007, and projected to hit positive leverage with assumed increases in revenues have very slim chance of achieving the proforma, and entering positive net cashflow universe. Instead, they have a much higher chance of entering the Watchlist, and gradually go delinquent

Karsang Sherpa is a vice president at Caldera Asset Management, a turnaround management and restructuring consulting firm specializing in multifamily assets. Caldera’s team has experience working with lenders, equity investors, lawyers and other consultants to solve complex problems associated with distressed multifamily assets including turnaround, refinancing, stabilization, restructuring, dispositions and property management. For more about Caldera, please visit www.calderaassetmanagement.com.