Overview
In 2022, we published an analysis on recovery rates for hotel and motel properties, based on foreclosure data in Commercial Real Estate (CRE) securitizations. This data was collected and provided to us by Trepp, the leading provider of data, insights, and technology solutions to the structured finance, commercial real estate, and banking markets. Using their collected information, we recommended a recovery rate of 40% on the initial appraised value of hospitality collateral. This article will discuss the office market, based on information collected by Trepp on the sale of foreclosed office collateral in securitized transactions.
The data was based on the sale of office collateral supporting defaulted loans within securitizations from January 2020 to the end of 2022. There were 114 transactions. The collateral was broken between suburban locations:
- (80 incidents)
- Urban (18)
- Medical (12)
- Other (4)
These properties were in 36 states. Texas with 12 had the largest number. This was followed by Ohio with 10, Illinois and Virginia with 9 each, and New York with 7. These properties were built from the turn of the previous century to 2009. Most of these transactions represented individual properties, a very few were a pool of properties. Since these are securitized deals, the dollar amounts are larger than the average for many community banks. The medium size on the loans was about $12 million, ranging from approximately $2 million to $200 million. Finally, the underlying collateral represented A, B and C class buildings.
Recovery Rate Calculation
The recovery rate calculation is the liquated proceeds divided by the appraised value of the collateral at the time the loan was securitized. The liquated proceeds represent the sale price of the building less any costs associated with that sale. It does not include any lost interest due during the period that the borrower stopped making payment and the liquidation of the property. This also doesn’t represent the actual loss to the investors, since most securitized deals start off with collateralization being 30% to 40% greater than the amount borrowed (Loan to Value (LTV’s) of 60 to 70%), while bank held borrowings often starts with an LTV of 75% to 80%.
While there are many reasons why CRE deals go into default and need to be liquidated, the main reason is the borrowers inability to sell the underlying property for an amount greater than the loan value. If a loan starts out with a LTV of 70%, the property can be sold with a recovery rate greater than 70% and the borrower will likely sell the collateral rather than letting the special servicer or bank foreclose. As a result, we would expect recovery rates to generally be below 70% to 80%. This is a situation where the property is sold below it is initial appraised value but above the amount owed generally does not default and go into foreclosure.
The following table shows for both all the properties and just the suburban collateral where recovery rates fall.
As shown, there are very few properties where the recovery rate is above 80%. While about 50% were in the 25% to 60% range and another 30% were below 25%, with some properties barely returning anything. One example of this very low recovery rate is the ATT building in downtown St. Louis MO. This 44-story building is the third highest structure in that city at 587 feet with over 1.2 million square feet and cost about $150 million to build in the mid-1980. It was sold in 2006 for about $200 million and ATT which occupied almost the entire building signed a lease until 2017.
In 2013 ATT announced it was moving all of its employees to other structures and would not renew the lease 2017. At the time of securitization, the appraised value of the building was slightly over $207 million. This dropped after the ATT announcement and in 2017, the owners went into default. After several attempts by the special servicer to dispose of the property, it was sold in 2022 for slightly over $4.2 million (after expenses) or a recovery rate of 2%. While this is an outlier, as noted in the table above, there were, a total of 11 transactions where the Recovery rate was below 10%.
We took an unweighted average of the entire sample of 114 deals and found the recovery rate was 38.1%, suburban properties had a slightly higher recovery rate of 38.7%, while Urban at 36.4% and Medical at 33.3% were lower. The question can be asked if the age of the building matters or the year the collateral was sold. The answer to both questions is yes, using the much larger suburban location information.
As the table below shows, older buildings have lower recovery rates. This may be due that they are more likely to be B and C class property than A. Also, 2020 was a tough year with the Covid lockdowns and the remote work environment, as such a lower recovery rate should be expected. However, the idea of the recovery rate is it use in determining Loss Given Default, a conservative approach may be more appropriate.
Recommendations
Based on the information presented we would recommend a recovery rate of about 38% on office properties. If you wanted to get a little more detailed, a 45% recovery rate could be used on Class A type properties and something in the 35% range for B and C and Medical facilities. Please contact the Q2 advisory group with any specific questions.