The economic disruption caused by COVID-19 and the efforts to contain it will trigger a new cycle of rising defaults and losses in the commercial real estate lending sector, according to a new Trepp research report titled COVID-19 Impacts on Commercial Real Estate: Rising Defaults and Losses in the Loan Sector. Trepp is a provider of information, analytics, and technology to the structured finance, commercial real estate, and banking markets.
In the scenario presented in this report, the cumulative default rate across commercial mortgages overall will rise to 8%, up significantly from the current 0.4% default rate.
The impact will be most immediate and severe in the lodging sector, with a cumulative default rate approaching 35%. The retail sector will also experience elevated defaults, with an estimated cumulative default rate of 16% in this scenario. Other major real estate sectors analyzed—office, multifamily, and industrial—will experience more measured increases in distress.
The loans are from Trepp’s T-ALLR data set, which comprise balance sheet loans held by commercial banks. The loans used for this analysis are commercial mortgage loans, spanning a broad range of size, geography, and property type.
The scenario used is a modified version of the bank regulators’ Severely Adverse scenario, with changes to capture the more significant expected declines in prices and NOI expected in the lodging and retail segments.
“To gauge the impact on commercial real estate mortgages, Trepp used the Severely Adverse scenario that regulators have created for large bank stress testing, says Matthew Anderson, head researcher of this study and Trepp managing director. “This scenario assumes that GDP falls precipitously, the unemployment rate rises (peaking at 10%), interest rates plunge, and asset prices fall.”
The results show that the application of the COVID-19 forecast scenario to the loan portfolio will drive default and loss rates higher for all types of commercial mortgages, especially the lodging and retail sectors. With values and NOI falling, LTV ratios will rise and DSCRs will fall, increasing the risk of default. With lower asset values and reduced liquidity, loss severity (LGD) will rise. The combination of higher default rates and higher loss severity means that expected loss rates will also increase.
For additional details such as projected changes in loss and default rate for each property type, the expected declines for retail and lodging in price and NOI, and the overall impact that COVID-19 will have on these loans, download Trepp’s full report here.