By Andrew McIntyre

Law360 (October 14, 2020, 5:15 PM EDT) -- With the COVID-19 pandemic barreling toward the end of 2020, owners of hospitality and retail properties have struggled to make their commercial mortgage-backed securities payments, but a new wave of problems could surface for other commercial real estate sectors.

Lawyers expect to see continued trouble in the hotel and retail sectors but also predict owners of office and multifamily properties could experience trouble making their loan payments or getting refinancing.

Experts also say CMBS lenders continue to struggle with the question of how to underwrite properties, given a host of uncertainties.

Here, Law360 looks at three areas of CMBS financing to watch as the pandemic continues.

Hospitality and Retail Continue to Face Distress

CMBS debt has been a common financing option for owners of hotel and retail properties, but those two asset classes have been hit the hardest during the pandemic amid steep drops in occupancy and spending at those properties. Such owners are likely to continue to face trouble making payments and getting refinancing.

Traditionally, hotels and resorts as well as retail properties have heavily relied on CMBS debt.

"A lot of those properties are tied up into CMBS loans because the structure is favorable for a lot of those borrowers," said Mark Silverman, a member of Dykema Gossett PLLC.

When it comes to retail and hospitality, new CMBS loans are just not happening during the pandemic, said Krystyna Blakeslee, a partner at Willkie Farr & Gallagher LLP.

And to the extent that CMBS debt deals are being stuck for that sector, such deals generally involve some sort of distressed situation, lawyers say. In those cases, particularly on the retail side, the lender may see an opportunity for a borrower to create more value by, say, repurposing the asset.

The shift toward online shopping put brick-and-mortar stores under stress, and online shopping has accelerated during the pandemic.

"In the retail and hospitality side, deals aren't getting done unless the assets are enormously distressed. Nobody's meeting eye to eye," said Brooks Clark, a shareholder at Polsinelli PC. "Distressed deals are getting done. [Retail] was an asset class … that was distressed already and COVID upended the whole apple cart."

And when it comes to retail, a major additional question mark is the future of the restaurant subsector.

Questions also loom as to whether Congress will pass another stimulus package similar to the one it passed earlier in the year that provided, among other things, $1,200 to many Americans. Congress and the White House have not been able to reach an agreement on the size and scope of another package.

"Everyone knows [retail is] weak. There's not that much farther it can fall," Clark said. "What I'm worried about is all the restaurant chains that are declaring bankruptcy. What happens there? And what happens if we don't get another stimulus package?"

Underwriting Is a Major Challenge

While borrowers are struggling to make their CMBS payments, lenders are also struggling to figure out what the underlying properties are worth, a critical part of underwriting for new loans or refinancing of preexisting debt.

"I haven't seen anybody come up with a very good way to value hospitality, retail or even office," Blakeslee said.

Lenders typically look at revenue stream as a key metric for valuing and property, and as hotel and retail properties saw revenue dry up during the quarantine this year, the underwriting challenge emerged. The big unknown early on was what future revenue would look like there, and on what time frame.

And those questions remain.

"We're in the second or third inning here … [in terms of the] impact on CMBS loans," said Ed Weil, a member at Dykema. "We're going to have to … take the long view of how this shakes out over the fourth quarter, or even all of 2021. … The fallout will be felt for years to come."

And now, office properties are also becoming increasingly tricky to underwrite.

Tom Henry, a partner at Willkie, said occupancy levels of office properties are key. Those properties leased for the coming five to seven years, he said, would have less difficulty getting refinancing. By contrast, a new Manhattan office tower that has 250,000 square feet or more of space available "will be pressed."

Blakeslee and Henry said that while a COVID-19 vaccine would help provide clarity on the underwriting question, determining a property's value will remain a challenge until people begin to adopt the transportation habits they had prior to the pandemic.

"Whatever brings the curve down nationally. Whatever will lead to people getting on subways and commuter trains," Henry said. "It's difficult for the CMBS lenders to get their arms around valuations. That's added to the chaos and stress in the system."

Office and Multifamily Could Face Distress

Office and multifamily have not been hit as hard as hospitality and retail since many companies have been successful having their employees work from home and renters had federal stimulus assistance this summer.

But with stimulus benefits for the moment having ended and the long-term office model in question, those two sectors could see trouble looming.

"What we haven't yet seen and expect to see is an increase in CMBS defaults on the multifamily and office side," Silverman said. "Those sectors have continued to perform, kind of, throughout the pandemic."

While eviction moratoria by states and the Centers for Disease Control and Prevention have given much-needed relief to tenants, those moratoria "negatively impact CMBS borrowers and could negatively impact … a borrower's ability to pay the mortgage," Silverman said.

"We've not seen a ton [of defaults] but could see that becoming a problem in the coming months," Silverman added.

Clark said the problems on the multifamily side, if they do materialize, will take time to play out. Clark noted that CMBS debt is not nearly as common for multifamily properties as it is for other asset classes.

"July and August were the last two months where everyone was paying their rent on time. We may start seeing it after the election or even a month longer," Clark said. "To the extent that you're going to see any distress in the multifamily sector, you're going to see it from the government not passing … relief."

And on the office side, business closures could put further stress on the CMBS market.

Weil said the office sector has a looming problem that's "potentially in a 'zombie category.' Retail and hotel are 'post-zombie.'"

"We have some loans in default in special servicing," Weil said, mentioning that lawyers in Dykema's Midwest and Los Angeles offices are working on some of those. "That wave is coming, too."

And Blakeslee said to continue to expect volatility in the CMBS market, particularly with added uncertainty as the U.S. presidential election nears.

"Ultimately, I see office changing a lot. Office will look a lot different," Blakeslee said. "Office will be tough in the short term but OK in the long term. We're still seeing some deals for Class A properties in urban areas."

--Editing by Orlando Lorenzo and Sarah Golin.

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