The conventional wisdom in the US commercial real estate markets is that the coming year could be a difficult one for borrowers, particularly those up against near-term maturities at a time when interest rates are rising, valuations are falling and the debt markets are paradoxically liquid and selective. 

While these technical factors likely mean an uptick in requests for extensions, forbearance and modifications, more lenders are envisioning a market where troubled loan transfers to special servicing for both balance sheet and commercial mortgage-backed securities loans are minimal and someday perhaps almost non-existent. 

Adam Fox, a senior director at Fitch Ratings, a New York-based rating agency, has observed an evolution in servicing in the CMBS market since the end of the global financial crisis that has helped reduce both loan transfers to special servicing as well as reducing the loss severity these loans experience. 

“The market has evolved in response to the way in which the capital markets have evolved,” Fox says. “Servicers are also working with a greater diversity of loan products than they did prior to the GFC, including single-family rentals and transitional loans. Loans are also more complex than they were 10 or 15 years ago and, from a servicing perspective, we are seeing technology become increasingly important to monitor and report externally about performing loans either for third-party clients or for a securitization.”

Different thinking

Regardless of which kind of lender originated a loan, a problem does not necessarily mean the loan needs to be transferred to special servicing, says Toby Cobb, co-founder and managing partner of 3650 REIT, a national mortgage lender which originates balance sheet and CMBS loans. This realization is one which has evolved over the past 15 years, first slowly in the wake of the GFC and then more rapidly as lenders who built their careers at banks went over to the private side of the business.

“There are many more loan originators in the capital markets which have shifted to investment management, asset managing their own loans,” Cobb says. “Those originators are frankly still the minority. For the most part, everyone in the business still outsources to a third-party servicer [but] loan asset management and servicing is [indeed] better in the post-global financial crisis era.”

In Cobb’s view – not unique in the US debt markets – loan servicing is not housed where it should be. This is in part due to what Cobb sees a misalignment of interests at banks and other lenders which originate loans for arbitrage (see related story, page 25). Balance sheet lenders, including insurance companies and debt funds, typically retain a portion of the loans they originate on their books and can service a loan for its entire life.

3650 REIT is rare in that it originates and securitizes loans in the CMBS market while also retaining servicing rights.

“We will own your loan for the life of the loan. We won’t sell your loan; we are not in the arbitrage business,” Cobb says. “I don’t know another firm that has that discipline, and there is no other firm that has that discipline in the 10-year, fixed-rate space. The idea that borrowers are okay with or attracted to the capital markets lending space because of servicing is still a farce. Every one of these conduit borrowers are holding their noses and doing it for the rate and proceeds.”

Maintaining the right to service a loan allows a lender like 3650 REIT to more easily handle requests around modifications or forbearance.

“In times of distress, portfolio lenders engage with their borrowers and create solutions to keep loans paying. That is the fundamental challenge with conduit lenders who don’t control their own servicing and own assets,” Cobb says.

Pockets of trouble

Although the question of distress is a major topic, so far precious little has been seen.

A July report from Trepp, a New York-based data and analytics provider, is tracking a steady decline in the US CMBS special servicing rate, which has fallen from 8.14 percent in July 2021 to 4.79 percent during the same period this year. Additionally, Trepp tracked a 128 basis point decrease in loans on servicer watchlists to 21.08 percent.

Per Trepp, there is an emerging narrative that CMBS data demonstrates that commercial real estate is relatively insulated from the turmoil seen in the broader financial markets. 

“Issuance has fallen off, specifically in what was a thriving CRE CLO market, but distress has continued to recede despite mounting economic concerns,” the report stated. “When the pandemic first happened, it was easy to explain the low distress as a by-product of loan extensions and forbearance but the markets continued ability to weather distress speaks to the safety of the market post-financial crisis regulations and changes to deal structures.”

The report’s assertion that the impact of post-GFC changes has been felt in performance is underscored with data from CMBS 1.0 and CMBS 2.0 deals. CMBS 1.0, or deals completed prior to the GFC, have a special servicing rate of 29.77 percent, compared with 4.47 percent for loans securitized in CMBS 2.0 and other key metrics support this divergence in performance (see CMBS special servicing chart).

Trepp’s report does, however, raise the specter of refinance risk and concerns about the future of the office market and this concern is one echoed by Adir Levitas, founder and chief executive officer at Hoboken, New Jersey-based industrial manager Faropoint.

“It’s very hard to find troubled loans,” Levitas says. What distress is being seen is in asset classes like retail malls or hotel or in markets like Houston, where there is a severe supply-demand imbalance in the office sector and high vacancy rates, he adds. 

Houston has been one of the markets where the office sector struggled substantially during the pandemic, with the overall average vacancy rate rising by 10bps to 23.5 percent from the first to second quarters, according to data from Colliers.

“Houston office is a bloodbath,” Levitas says. “If you’re looking for troubled loans, I would start with a sector like that, where occupancies are lower. I would also look at loan maturities and call local banks to see if they have troubled assets that might become troubled loans in their portfolios. It’s good to be within their visibility if something like that comes into play.”

The industrial sector, where Faropoint is focused, is not expected to see the same kind of distress as the sectors that have been most affected covid.

“[Although] they’re not building enough of the last-mile product and are building more of the big product, even if that big product is not completely absorbed, it’s usually done by institutional players that [have] lower leverage and the wherewithal to carry on those assets, so I don’t see much of that becoming an opportunity,” Levitas says.


Volume of CMBS resolutions in 2022, an uptick from the less than $8bn seen annually from 2018-20


Percentage of total loan resolutions without losses or returned to the special servicer, an increase from the 60% seen in 2020


Percentage of resolutions involving retail or hotel loans

A mid-year report from Fitch Ratings paints a positive look back at CMBS loan resolutions, with only 25 percent disposed of with losses as special servicers worked through pandemic-era loan transfers.

Karen Trebach, a senior director at Fitch, believes this trend will continue as the US moves past covid-related disruptions.  

The agency found total resolutions rose from $8 billion to $15.5 billion in 2021 and almost 75 percent of these resolutions were resolved without losses or returned to the master servicer. This is a big uptick from the roughly two-thirds of loans which achieved this milestone in 2020, when about 60 percent of resolutions that were returned to the master servicers received modifications or forbearance.

What’s next

3650 REIT’s Cobb acknowledges an  improvement in traditional third-party servicing since the end of a the GFC and during the pandemic but sees a world where the number of loans transferred to special servicing could be virtually zero.

“In times of distress, portfolio lenders engage with borrowers so that the loans pay because that is what their business is – making loans that pay. Their business is not servicing or special servicing. That is the challenge with the capital markets lenders who don’t control their own servicing or own assets,” Cobb says. 

“Real estate is a dynamic asset, and things change. If you don’t have the ability to engage in a constructive dialogue with the borrower, how can they manage their property? It becomes very difficult.”

Over the long term, Cobb expects to see more borrowers gravitate toward portfolio lenders. “There is no question we saw better behavior during the pandemic from special servicers, but still 12.5 percent of loans went in and there is a cogent argument that this could be closer to zero,” Cobb says. “At 3650 REIT we have $12.8 billion of cumulative serviced loans and have one loan of $14 million in special, that’s darn close to zero.”

How it works

There are two primary ways loans are serviced. For a balance sheet lender like an insurance company, a bank or debt fund, servicing is performed in-house and asset managers have the ability to perform functions that include providing modifications and offering forbearance or extensions. 

For lenders that originate loans to sell via the CMBS market, a third-party master servicer oversees a loan for its life. Third-party servicers also provide master and special servicing for third parties for loans not included in securitizations. 

Part of a CMBS master servicer’s job is to catalogue potential problems via a watchlist and communicate with borrowers early in the game about issues with loans. While a master servicer, particularly in the post-GFC period, has some flexibility to work with borrowers, more significant problems mean a loan will be transferred to a special servicer. A transfer to special servicing typically means a one-time fee as well as additional fees related to legal costs obtaining valuations.