Morgan Stanley sees K-shaped recovery for commercial real estate

[NEW YORK] Morgan Stanley says commercial real estate will see a so-called K-shaped recovery from the pandemic, leading to stark winners and losers among holders of commercial mortgage-backed securities (CMBS).

This bifurcation means that some deals will experience much higher realised losses than others, depending on factors such as bond, vintage and property type. Bonds backed by hotels, retail and offices are likely to see more struggles than those on industrial properties.

The split creates a market where due diligence and active management is key as investors seek to gain an upper hand amid the chaos.

"A bond picker's market has emerged," a team of Morgan Stanley analysts led by Richard Hill wrote in an outlook report Wednesday. For instance, a "market of 'haves' and 'have-nots' has emerged in BBB- (CMBS bonds), as idiosyncratic risks and rising loss expectations magnify quality tiering". This has led to scant trading opportunities for older BBB- CMBS conduit tranches. Investors are unwilling to sell the higher-quality bonds, while the lower-quality bonds lack sponsorship, the analysts wrote.

The CMBS market has struggled this year as Covid-19 kept shoppers out of malls, travellers away from hotels and workers home from offices. More than 1,400 CMBS loans totalling US$29.3 billion are currently delinquent, Morgan Stanley said. Lodging and retail properties have the highest delinquencies, at 22.6 per cent and 11.8 per cent, respectively.

To make things more complicated, the overall CMBS headline delinquency rate of 7.8 per cent "may be understated by 300 to 400 basis points, given a combination of forbearance and borrowers drawing down on reserves to pay current principal and interest payments", the report said.

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The bank's expected-loss projections for CMBS conduits are in an average range of 5-7 per cent, depending on which year a CMBS was issued. That could exceed 10 per cent and even hit the high teens for specific deals that are more troubled, the report said.

Losses may reach as high as the AA ratings tier in certain bear-case scenarios, the Morgan Stanley research show, while lower-ranked classes will almost definitely see some realised losses, depending on the transaction.

"There is a wide range of deal-by-deal losses across all vintages," Mr Hill wrote, noting that additional stresses on lodging, retail, and office properties may cause loss projections to rise.

Despite the challenging picture of performance, CMBS issuance next year may surprise to the upside. The bank projects US$60 billion to US$70 billion in 2021 sales across conduit, single-asset, single borrower and commercial real estate collateralised loan obligation offerings as maturities come due.

CMBS sales have reached about US$54.4 billion so far this year, more than 40 per cent lower than the same span in 2019, according to data compiled by Bloomberg.

BLOOMBERG