COVID-19 Risks in CMBS Markets

Co-authored by Nils Kok

Freddie Mac recently announced an extension of its multifamily forbearance program, meant to provide needed relief to landlords (and tenants) impacted by COVID-19-related job losses. According to Fitch, 105 borrowers requested relief on some $810 million of multifamily mortgages. Investors in Freddie’s K-Series CMBS offerings may be somewhat relieved. After all, this $810 million represents just 0.03% of the original loan amount for mortgages in the K-Series. 

However, there is a strong possibility that more landlords will seek forbearance as tenants miss rent payments due to the labor market’s continued implosion and as job losses across the country continue to balloon. Indeed, as our most recent GeoPhy Neighborhoods report indicates, K-Series investors shouldn’t be blasé about the risk that COVID-19 poses to their investment.

Originally developed to rank 90,000+ neighborhoods on their investment attractiveness, GeoPhy Neighborhoods synthesizes hundreds of data points. We recently adjusted our algorithm to understand the risk implications of COVID-19 for the multifamily market. Using this data, lenders and investors can learn which of their assets are in neighborhoods with the highest risk of missed rental payment resulting from the toxic combination of high rent-to-income ratios and large shares of the local labor force (previously) working in COVID-19-impacted industries.

Using this COVID-19 analysis, we examined the K-Series data of Freddie Mac – one of the largest lenders in the US multifamily space. The K-Series securities are part of the $3 trillion commercial mortgage-backed securities (CMBS) market. More than 26,000 commercial real loans, including both acquisition and refinancing loans, have been securitized through the Freddie Mac K-Series since 2003. Focusing on just 2019 and 2020 (year-to-date), that number is about 3,400 loans, with a collateral value of $84 billion. Many pension funds, insurance companies, and other institutional investors gain exposure to the US commercial real estate market through the K-Series. The Freddie Mac K-Series program is significant.

We assessed which multifamily properties included in Freddie Mac’s K-Series CMBS are also located in the top 10% of neighborhoods with COVID-19 layoff/furlough risk. We call these high-risk neighborhoods. Of the K-Series’ 24,117 properties, 33% are located in high-risk neighborhoods – three times more than what would be expected if K-Series properties were distributed uniformly across the country. These properties represent around 24% of all K-Series units or individual apartments, 24.4% of K-Series loans, and 24% of total NOI generated by apartments in the K-Series. 

Some states are worse off than others. California, Texas, New York, and Florida have the most K-Series properties of any state. The share of each state’s properties in risky neighborhoods, however, varies widely. Only 17% of K-Series properties in Texas, for example, are in high-risk neighborhoods. Things are not as rosy in New York: 67% of its 2,158 K-Series properties are in high-risk neighborhoods. 

Within the New York metropolitan area, some neighborhoods stand out as particularly threatened. A large swath of high-risk Brooklyn neighborhoods, reaching from Crown Heights to South Williamsburg to Bushwick, contains 202 K-Series properties that collectively earn a net income of $52 million per year. To put this into perspective, this is 27% of all K-Series properties in Brooklyn, and 22% of K-Series loans in Brooklyn. Before COVID-19, these neighborhoods were rated either A or A+. 

Securitization is meant to reduce an investor’s exposure to idiosyncratic risks. However, we found some massive K-Series deals with a risk-concentration that few people could have anticipated two months ago. The largest deal we identified contains over 330 properties in California and Washington. This is a large CMBS deal (with $670 million in loans) with high-quality assets (74% are in A or A+ Neighborhoods). However, over half of these loans are backed by properties in high-risk neighborhoods for COVID-19 layoffs/furloughs.

Some deals are even larger in value and substantially less diversified. One K-Series CMBS deal in Los Angeles is backed by a single property of 4,200 apartments. It is valued at $1.7 billion dollars. This property’s neighborhood is ranked #11 of the more than 90,000 neighborhoods rated by GeoPhy’s COVID-19 risk score. That places it in the top 0.01 percent of all neighborhoods nationally. 

As COVID-19 continues its deadly spread across the country, the direct and indirect economic implications are becoming ever more apparent. With applications for unemployment benefits at 22 million over the past four weeks, some argue we’ll soon be at an unemployment rate of 18 percent. This will likely translate in a wave of missed rent payments that could increasingly threaten landlords’ income and, possibly, lead to mortgage payment delinquencies. This has consequences for the ultimate providers of capital – the pension funds, insurance companies, and endowments that own multifamily mortgages through CMBS securities. 

The timing and extent to which layoffs and furloughs will negatively affect rent payments is unclear; the Paycheck Protection Program, enhanced unemployment benefits, and SBA loan programs may prove effective. However, it is critical for investors and lenders today to use data strategically as they develop plans to assess the potential impact on their portfolios given the scenarios that could play out.

To learn more about GeoPhy Neighborhoods or to order a report for your portfolio, please visit www.geophy.com/neighborhoods.