DBRS Morningstar Assigns Provisional Ratings to ILPT Commercial Mortgage Trust 2022-LPF2

DBRS, Inc. (DBRS Morningstar) assigned provisional ratings to the following classes of Commercial Mortgage Pass-Through Certificates, Series 2022-LPF2 to be issued by ILPT Commercial Mortgage Trust 2022-LPF2:

-- Class A at AAA (sf)
-- Class B at AA (low) (sf)
-- Class C at A (low) (sf)

All trends are Stable.

The ILPT Commercial Mortgage Trust 2022-LPF2 (ILPT 2022-LPF2) transaction is collateralized by the borrower’s fee-simple or leasehold interests in a portfolio of 105 cross-collateralized properties totaling 18.6 million sf. The portfolio is spread across 31 states and 54 different markets, including Hawaii (16.7% of DBRS Morningstar base rent), Charleston, South Carolina (7.4% of DBRS Morningstar base rent), and Miami (5.4% of DBRS Morningstar base rent). The properties themselves are a mix of warehouses and manufacturing. Overall, the subject markets have solid fundamentals with positive annual growth in rents while absorbing new supply and compressing vacancies. DBRS Morningstar continues to take a favorable view on the long-term growth and stability of the warehouse and logistics sector. The portfolio benefits from favorable tenant granularity, favorable asset quality, and strong leasing trends, all of which contribute to potential cash flow stability over time.

The portfolio mainly consists of single-tenant properties with triple net leases and is 96.8% occupied to 77 individual tenants. The most prominent tenant in the portfolio is FedEx, which accounts for approximately 31.0% of the DBRS Morningstar base rent. Other prominent investment-grade tenants include The Home Depot, Exel Inc., and General Mills. Furthermore, approximately 50.7% of the total leased net rentable area (NRA) is leased by investment-grade tenants. The largest property in the portfolio is 91-399 Kauhi located in Kapolei, Hawaii, which entered into a ground lease with The Home Depot that commences in April 2024. 91-399 Kauhi also contributes the most base rent to the portfolio, followed by 9215-9347 E Pendleton Pike, 996 Paragon Way, 11224 Will Walker Road, and 32150 Just Imagine Drive, which are located in Lawrence, IN; Rock Hill, SC; Vance, AL; and Avon, OH, respectively.

The transaction sponsor, ILPT, is a publicly traded real estate investment trust formed to own and lease industrial and logistics properties throughout the United States. As of June 30, 2022, ILPT owned 412 industrial and logistics properties that totaled 59.7 million square feet (sf) that are approximately 98.9% leased to 398 unique tenants. Furthermore, the weighted average lease term (WALT) of their portfolio is approximately 9.2 years. Approximately 71% of the annualized rental revenue comes from 186 industrial and logistics properties with approximately 43.0 million sf across 38 states. The remaining annualized rental revenue comes from 226 properties totaling approximately 16.7 million sf in Hawaii. At most of these properties, ILPT is engaged in long-term ground leases with tenants who have built industrial properties and warehouses.

Approximately 55.7% of DBRS Morningstar base rent is derived from investment-grade-rated tenants, including FedEx (Moody’s: Baa2/S&P: NR/Fitch: BBB; 31.0% of DBRS Morningstar base rent), The Home Depot (Moody’s: A2/S&P: A/Fitch: A; 5.1% of DBRS Morningstar base rent), Exel Inc. (Moody’s: A3 /S&P: BBB+/Fitch: NR; 3.6% of DBRS Morningstar base rent), and General Mills (Moody’s: Baa2/S&P: NR/Fitch: BBB; 2.6% of DBRS Morningstar base rent). The largest property represents 5.1% of DBRS Morningstar base rent with the top five and 10 properties representing 19.3% and 32.8% of DBRS Morningstar base rent, respectively. The portfolio has a WALT of 4.6 years for all properties, excluding the leased fee properties, and the leased fee properties exhibit a WALT of 16.5 years.

The transaction benefits from elevated cash flow stability attributable to multiple property pooling. The portfolio has a property Herfindahl score of 51.5 by allocated loan amount (ALA), which provides favorable diversification of cash flow when compared with a single-property securitization. No single property accounts for more than 12.0% of the portfolio’s NRA, and no single tenant accounts for more than 31.0% of DBRS Morningstar base rent in the DBRS Morningstar net cash flow (NCF) analysis. Across the entire portfolio, the in-place tenants are paying relatively lower rental rates compared with the market rental rate as determined by the appraiser. Specifically, the in-place rental rate based on the rent roll provided is approximately -10.2% below the weighted average (WA) market rent determined by the appraiser. Thus, if market conditions don’t deteriorate, it is possible for the sponsor to increase rental rates as tenants expire and increase the portfolio’s cash flow.

The portfolio is primarily composed of warehouse/distribution and light industrial flex properties, with good WA clear heights of 29.1 feet and a relatively new WA year build of 2004. The portfolio also has a comparatively low percentage of office space at just 5.5% of the portfolio NRA. DBRS Morningstar made an upward adjustment of 2.75% to the loan-to-value ratio (LTV) hurdles to account for the superior property quality. Thirty-five assets within the portfolio are in the state of Hawaii, including 28 leased-fee and seven fee-simple assets. Generally, leasehold properties in Hawaii are relatively rare within the CMBS universe of securitized loans, and land is relatively more valuable than in other regions of the United States.

The mortgage loan has a partial pro rata/sequential-pay structure, which allows for pro rata paydowns for the first 20.0% of the unpaid principal balance. DBRS Morningstar considers this structure to be credit negative, particularly at the top of the capital stack. Under a partial pro rata paydown structure, deleveraging of the senior notes through the release of individual properties occurs at a slower pace compared with a sequential-pay structure. DBRS Morningstar applied a penalty to the transaction's capital structure to account for the pro rata nature of certain prepayments.

Industrial Logistics Properties (ILPT) reduced its dividend to $0.01 per share, a -97% decrease from the prior dividend of $0.33 ILPT management said: "ILPT is reducing its quarterly dividend to enhance its liquidity until it completes its long term financing plan for the Monmouth acquisition and/or its leverage profile otherwise improves. ILPT currently anticipates that its dividend will return to a rate at, or close to, its historical level sometime in 2023.” Equity prices dropped to $6.85 per share as of September 1, 2022, from $25.41 per share on September 1, 2021.

The capital stack includes one mezzanine tranche totaling $135.0 million. This additional mezzanine debt increases the DBRS Morningstar All-In LTV to 102.4% from 114.8%. A default on the mezzanine debt may potentially complicate workout negotiations or other remedies for the trust. DBRS Morningstar views this as credit-negative given the additional NCF stress that occurs when subordinate or mezzanine debt is present.

Leases representing 55.0% of the portfolio’s NRA are scheduled to roll through the end of 2027, which is the year the loan matures. The rollover is relatively granular with the exception of 2023 and 2024, in which 12.8% and 21.2% of the portfolio’s NRA rolls, respectively. It is notable that the original maturity date will be in late 2024, at which point the portfolio will have experienced a fair amount of roll during the prior 24 months. There are no performance requirements or hurdles in order for the sponsor to execute an extension option, other than no ongoing event of default. As a result, portfolio performance could be deteriorating at the same time the sponsor is attempting to execute an extension option on the mortgage.

The 91-399 Kauhi property, representing 5.9% of the allocated loan amount, is currently leased by Par Hawaii Refining, LLC, and The Home Depot has the option to terminate the lease by providing written notice to the landlord by December 27, 2022, as The Home Depot is still to determine the feasibility of constructing a warehouse/distribution facility on the parcel. DBRS Morningstar penalized proceeds to A from AAA to account for the risk associated with the possibility of the lease termination option.

According to documents provided by the borrower, approximately 462,569 sf of space is subleased by 12 tenants, which amounts to approximately 2.5% of the entire NRA in the portfolio, and these 10 properties represent 6.7% of the ALA. Despite the relatively moderate amount of subleased space, the subtenants are paying a higher WA rental rate of $6.89 psf compared with the WA in-place contractual rental rate of $5.64 psf.

There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

The DBRS Viewpoint platform provides additional information on this transaction and underlying loans including DBRS Morningstar metrics, commentary, servicer-reported cash flows, and other performance-related data. For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com.

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 (June 10, 2022), which can be found at dbrsmorningstar.com/about/methodologies. Links to the methodology(ies) referenced in this transaction are listed at the end of this press release. 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.

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.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrsmorningstar.com.

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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North American Single-Asset/Single-Borrower Ratings Methodology, (June 10, 2022; https://www.dbrsmorningstar.com/research/398247)