DBRS Morningstar Confirms Ratings on All Classes of COMM 2022-HC Mortgage Trust

DBRS Limited (DBRS Morningstar) confirmed its ratings on all classes of the Commercial Mortgage Pass-Through Certificates, Series 2022-HC issued by COMM 2022-HC Mortgage Trust as follows:

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

All trends are Stable.

The rating confirmations and Stable trends reflect DBRS Morningstar’s overall outlook of the transaction, which remains in line with issuance expectations, as the sponsor continues to execute their business plan of leasing up the remaining vacant space and stabilizing the property.

The loan is secured by the borrower’s fee-simple interest in Hudson Commons, a 697,960-square-foot (sf), Class A, LEED Platinum office tower located on Ninth Avenue between West 34th Street and West 35th Street in the Penn Station submarket of Manhattan, New York. The property was built in 1962 and renovated between 2012 and 2018 by the seller, a joint venture of Cove Property Group LLC and The Baupost Group LLC. Renovations of more than $800 million primarily consisted of upgrading and reinforcing the existing structure, in addition to constructing an additional 17-story, 304,301-sf glass tower of office space directly above the existing structure.

The property is split into two condominium units that both serve as collateral for the loan: the original nine-story podium base and the additional 17-story glass tower. Following a competitive bidding process with numerous institutional offers, a joint venture between CommonWealth Partners LLC (CWP) and the California Public Employees’ Retirement System (CalPERS) purchased Hudson Commons for approximately $1.03 billion ($1,480 per square foot (psf)).

Whole loan proceeds of $507 million, along with $588 million of borrower equity (53.7% of the cost), were used facilitate the acquisition of the property, fund a $35.5 million TI/LC reserve and a $7.9 million free rent reserve, and cover closing costs. The $507 million loan is composed of seven promissory notes: six senior A notes totaling $305 million and one junior B note of $202 million. The $467 million subject transaction consists of five senior A notes totaling $265 million and the junior B note. The remaining $40 million note is held in the BMO 2022-C1 transaction (not rated by DBRS Morningstar). The loan is interest-only throughout its five-year term with a scheduled maturity in January 2027.

As of the September 2022 rent roll, the property was 77.7% occupied, an increase from 72.7% at issuance. Two new tenants, FZN US Platform Co Inc. (5.1% of net rentable area (NRA), lease expiring June 2034) and Fireblocks, Inc (1.4% of NRA, lease expiring September 2025) signed new leases in 2022, with initial rates of $173.99 psf and $122.00 psf, respectively, well above the subject’s in-place rental rate of $97.32 psf at issuance. These tenants will receive rental abatements of 20 months and three months, respectively. As of Q3 2022, Reis, Inc. reported that comparable Class A office properties within a one-mile radius of the subject had vacancy and average rental rates of 3.0% and $83.35 psf, respectively.

The largest tenants are Peloton Interactive, Inc. (Peloton; 48.1% of NRA), and Lyft, Inc. (Lyft; 14.4% of NRA) with scheduled lease expirations in December 2035 and November 2029, respectively. Both Peloton and Lyft have termination or contraction options in their respective leases. Lyft’s first termination option is in December 2026, where the tenant can terminate its entire space with 18 months’ notice and a termination fee of $6.5 million ($65 psf). Peloton’s first contraction option is in December 2030, where the tenant can terminate portions of its lease with 15 to 27 months’ notice and a termination fee equal to the amount of principal remaining unpaid at a rate of 10% per annum compounding monthly. Both of these options are outside of the loan term.

Further mitigating these concerns is the fact that both tenants have invested significantly into their spaces, with Peloton investing $167.9 million ($500 psf) and Lyft investing $17.6 million ($175 psf), in addition to their tenant improvement packages, demonstrating long-term commitment to the property. In addition, excess cash flow, up to $100 per rentable square foot will be swept for the two largest tenants (Peloton and Lyft) upon the earlier of (1) the date 12 months prior to the lease expiration date; (2) the date each tenant is required to give notice of its exercise of a renewal option; (3) the early termination, early cancellation, or early surrender of a major tenant lease; (4) a major tenant goes dark; (5) default of the lease; or (6) bankruptcy of a major tenant or its parent company.

According to the June 2022 year-to-date financials (the most recent reporting available), the loan reported an annualized trailing-six month (T-6) net cash flow (NCF) of $21.7 million, below the DBRS Morningstar NCF derived at issuance of $40.0 million; however, a temporary, short-term decline in cash flow resulting from ongoing tenant abatements was expected and is not material to DBRS Morningstar’s overall credit opinion of the transaction. The loan’s Q2 2022 debt service coverage ratio (DSCR) was reported at 1.21 times (x), below the DBRS Morningstar issuance DSCR of 1.53x (x). According to the January 2022 loan level reserve, approximately $33.5 million remained in the TI/LC reserve, with $2.4 million in the free rent reserve.

While the collateral has yet to stabilize and the physical vacancy rate remains elevated at 22.3%, DBRS Morningstar concluded to a stabilized economic occupancy of 92.5% for the property at issuance, given the superior quality of the property, strong institutional sponsorship, its location in a premier New York office market, the lack of any rollover during the five-year loan term along with a strong loan structure including upfront reserves for future accretive leasing. To achieve the DBRS Morningstar stabilized occupancy, management needs to lease-up approximately 100,000 sf at a total cost of approximately $17.2 million ($166 psf) based on DBRS Morningstar’s TI/LC assumptions, which is below the remaining $33.5 million of reserves dedicated to accretive leasing costs. In addition, the DBRS Morningstar stabilized value of $886 psf is significantly lower than the appraiser’s comparable office sales, which averaged $1,207 psf across eight transactions that DBRS Morningstar deemed comparable at issuance. It is also approximately 29.4% below the $1,146 psf invested by the seller to gut renovate the property.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 (May 17, 2022).

Class X is an IO certificate that references 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.

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

The principal methodology is North American CMBS Surveillance Methodology (October 3, 2022), 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/407678.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

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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