DBRS Morningstar Finalizes Provisional Ratings on HONO 2021-LULU Mortgage Trust

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of HONO 2021-LULU Mortgage Trust Commercial Mortgage Pass-Through Certificates issued by HONO 2021-LULU Mortgage Trust (HONO 2021-LULU):

-- Class A at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)
-- Class D at BBB (low) (sf)
-- Class X-CP at BBB (sf)
-- Class X-EXT at BBB (sf)
-- Class E at BB (low) (sf)
-- Class F at B (low) (sf)

All trends are Stable.

The balances for Classes X-CP and X-EXT are notional.

The HONO 2021-LULU transaction is secured by the borrower’s leasehold interest in a 1,230-room, full-service luxury resort with 94,961 square feet (sf) of retail space in the Waikiki neighborhood of Honolulu. The property is situated along the renowned Kalakaua Avenue and directly across from the popular Waikiki Beach. Kalakaua Avenue is one of the main thoroughfares on the island of Oahu and widely considered a premier destination for shopping, entertainment, and gastronomy. Built in 1976, the property underwent a complete renovation in 2014 and 2015 for a reported $100.0 million ($81,300 per room) and was subsequently acquired by the sponsor in 2016 for $780.0 million (approximately $634,000 per room). The property is managed by the Hyatt Corporation (Hyatt) and has operated under the Hyatt Regency flag since it opened. The sponsor is an affiliate of Mirae Asset Global Investments Co., Ltd (Mirae), a global real estate investment firm with over $215 billion under management as of June 2021. The sponsorship group currently owns a portfolio of 50 assets valued at nearly $14 billion across various property types, including office, industrial, multifamily, and hospitality.

Historically, the property’s hotel and retail components have performed considerably well given its Hyatt brand affiliation and irreplaceable location in Waikiki’s main shopping and dining district. Additionally, the property offers upscale accommodations and amenities, which drive demand and help generate substantial room nights. Between 2015 and 2019, the hotel’s average occupancy was 90.8%, with the average daily rate (ADR) averaging between $253.67 and $275.74 annually during that five-year period. Similarly to the rest of the global lodging industry, the subject property has not been immune to the negative effects of the Coronavirus Disease (COVID-19) pandemic and operations continue to be affected by travel restrictions. The hotel is currently operating at depressed occupancy and revenue per available room (RevPAR) levels, and the trailing 12 months (T-12) financials are not representative of stabilized performance. As of the T-12 ended July 31, 2021, the hotel’s occupancy, ADR, and RevPAR were 22.1%, $210.38, and $46.56, respectively. At year-end (YE) 2019, the last full year of stabilized operations prior to the start of the pandemic, the hotel achieved occupancy, ADR, and RevPAR of 90.7%, $275.74, and $250.03, respectively. The property’s operations will likely not improve anytime soon as rising coronavirus case counts related to the delta variant continue to force local and state authorities to implement new restrictions on social gatherings. However, since the onset of the pandemic, the sponsor has invested $90.9 million to establish reserves, maintain adequate working capital, and cover operating and debt service shortfalls. The sponsor has a total cost basis of $891.0 million, resulting in equity invested after the loan proceeds equal to $441.0 million.

As is the case with most beachfront development in Hawaii, the property is encumbered by ground leases. The improvements are situated on one city block composed of nine separate tax parcels that are subject to four long-term ground leases. The primary hotel and retail structure is subject to two separate ground leases, while the convention space and parking garage are each subject to a separate ground lease. All four ground leases are scheduled to expire on December 21, 2087, and contain rent provisions that escalate at five- and 10-year intervals.

The collateral consists of a high-quality full-service hotel and resort in Waikiki, a high-barrier-to-entry urban neighborhood in Honolulu. The property features 1,230 guest rooms, nearly 95,000 sf of open-air retail space, 20,510 sf of meeting and event space, and various other amenities including a 10,000 sf full-service spa. In addition to rooms revenue, the subject generates revenue from alternative sources including food and beverage, retail, resort fees, space rentals, and commissions, among other items.

The property benefits from its long-term affiliation with Hyatt, one of the leading operators of hotels and resorts with a current portfolio of more than 1,000 properties across 68 countries. The collateral has operated under the Hyatt Regency flag since it opened in 1976 and the current management agreement runs through December 31, 2062.

The property demonstrated strong performance metrics prior to the onset of the coronavirus pandemic with 2019 occupancy, ADR, and RevPAR penetration rates of 107.9%, 97.7%, and 105.4%, respectively. These figures were an improvement from the 2018 occupancy, ADR, and RevPAR penetration rates of 101.0%, 97.8%, and 98.8%, respectively. Even as disruptions from the pandemic began to be felt in early 2020 as travel restrictions were implemented throughout the world, the property achieved overall occupancy, ADR, and RevPAR penetration levels of 107.7%, 97.1%, and 104.6%, respectively, as of the T-12 ended March 31, 2020. Furthermore, from 2015 to 2019, the hotel’s average occupancy was 90.8%, with ADR averaging between $253.67 and $275.74 annually during that five-year period.
The property benefits from experienced, institutional quality sponsorship in Mirae. Founded in 1997, the investment firm currently owns and manages eight luxury hotels worldwide, including the Fairmont San Francisco and the Fairmont Orchid in Hawaii. As of June 2021, Mirae reported more than $215 billion in assets under management.
The sponsor purchased the property in 2016 for $780.0 million, contributing $288.0 million of cash equity as part of the transaction. Since the acquisition, the sponsor has invested an additional $10.9 million in capital expenditures. The sponsor is injecting an additional $118.6 million of cash equity as part of the current refinancing. Since the onset of the coronavirus pandemic, the sponsor has invested $90.9 million to establish reserves, maintain adequate working capital, and cover operating and debt service shortfalls. All in all, the sponsor’s total cost basis is $891.0 million, representing an implied equity of $441.0 million.

The ongoing coronavirus pandemic continues to pose challenges and risks to virtually all major commercial real estate property types, creating a substantial element of uncertainty around the recovery of demand in the hospitality sector, even in stronger markets that have historically been highly liquid. As a result of the pandemic, the hotel’s occupancy and RevPAR declined from 90.7% and $248.31 as of YE2019 to 22.1% and $46.56 as of the T-12 ended July 31, 2021. The subject was the only hotel in its competitive set to remain open throughout the coronavirus pandemic. All debt service associated with the property’s existing financing is current and there have been no requests for forbearance.

DBRS Morningstar’s net cash flow (NCF) and value reflects an occupancy assumption of 89.0% which is well above the property’s 22.1% occupancy as of the T-12 ended July 31, 2021. DBRS Morningstar elected to stabilize the property and assumed occupancy in line with its prepandemic performance given the long-term brand affiliation and quality of the improvements, strong operating history, location in a high barrier to entry market, and the experienced management/sponsorship. DBRS Morningstar accounted for this stabilization risk by applying minimal adjustments to its loan-to-value thresholds. The property’s various revenue streams were considered credit neutral, and therefore, DBRS Morningstar did not apply a penalty or credit related to Cash Flow Volatility.

The property recorded negative NCF during the YE2020 and T-12 ended July 31, 2021 periods. Similar to the rest of the hospitality industry, the hotel has been negatively affected by the coronavirus pandemic as travel restrictions are still prevalent in most parts of the world. The loan is structured with a 12-month debt service reserve totaling $17.6 million, which should be sufficient to cover any ongoing operating losses from depressed occupancy at the property.

The property’s last full renovation occurred in 2014 and 2015 when the previous owner invested approximately $100 million to upgrade the guest rooms, common areas, and building equipment/systems. Since then, the property has continued to receive general capital expenditures and preventive maintenance; however, a more comprehensive renovation plan will be required to maintain the property’s quality. Failure to do so will lead to a deterioration of the building and amenities, which could affect the hotel’s ability to achieve favorable occupancy and RevPAR levels. DBRS Morningstar had the opportunity to tour the property and found the improvements to be in very good condition with no deferred maintenance observed. Since acquiring the property in September 2016, the sponsor has reportedly invested an additional $10.9 million ($8,845 per room) in various repairs and updates, including $3.0 million on building coatings and sealers, and $2.7 million on elevator modernizations.

The entire property is subject to four long-term ground leases, which are scheduled to expire on December 21, 2087, and contain rent provisions that escalate at five- and 10-year intervals. The current ground rent totals approximately $14.4 million and represents 9.7% of the DBRS Morningstar total revenue. The appraisal forecasts that the ground rent will escalate to $18.4 million and $20.5 million by 2026 and 2027, respectively. The increasing ground rent may negatively affect the property’s NCF and, ultimately, the sponsor’s ability to refinance the loan at the fully extended maturity date. By 2026, the appraisal estimates the property’s occupancy and ADR will be 92.0% and $318.54, respectively, which is considerably higher than the DBRS Morningstar NCF assumptions. Furthermore, DBRS Morningstar accounted for the leasehold interest risk in the concluded cap rate of 10.09%, which is about 200 bps higher than the DBRS Morningstar estimated cap rate of 8.0% for the fee simple. This results in a discount of approximately $80 million in value versus the fee simple.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Classes X-CP and X-EXT are interest-only (IO) certificates that reference a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

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Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is North American Single-Asset/Single-Borrower Ratings Methodology (March 2, 2021), which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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