DBRS Morningstar Confirms Ratings on All Classes of BBCMS 2018-TALL Mortgage Trust

DBRS Limited (DBRS Morningstar) confirmed its ratings on all classes of the Commercial Mortgage Pass-Through Certificates, Series 2018-TALL issued by BBCMS 2018-TALL Mortgage Trust as follows:

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

All trends are Stable.

Although the collateral for the underlying loan has seen a contraction in occupancy and cash flow, which may be further exacerbated by softening office market fundamentals and continued uncertainty related to end-user demand, the subject property is a high-quality office tower well located along Wacker Drive in the West Loop submarket, one of the most desirable areas in Chicago’s central business district. Further, the transaction benefits from strong sponsorship provided by The Blackstone Group L.P., which has invested upward of $490 million toward upgrading the office, retail, and Skydeck Observation Deck (SkyDeck) space at the property. In addition, the asset has multiple and diverse income-generating components, including office, retail, Skydeck, and antenna revenue streams.

The $1.3 billion transaction is backed by the borrower’s fee-simple interest in Willis Tower, a 3.9 million square-foot (sf), Class A office building, which includes a 300,000-sf retail and entertainment annex known as the Catalog, located at the south entrance of the building. The Catalog provides access to the Skydeck that reopened in April 2021 after undergoing an extensive redevelopment of its lower level, which features an interactive museum that celebrates the history of Chicago’s neighborhoods and historical sites. The observation deck, situated on the 103rd floor, features four glass-floor balconies extending from the tower called The Ledge, which attracts more than 1.7 million visitors annually. The Skydeck generates approximately 20.0% of the property’s total effective gross income.

Loan proceeds were used to pay off existing debt and fund reserves of $86.9 million, with the sponsor cashing out $240.0 million of equity as part of the transaction. While there was no additional debt at issuance, future mezzanine debt up to $150.0 million is permitted, subject to hurdles. The interest-only floating-rate loan had an initial term of two years with five 12-month extension options. The loan bears interest at a 1.38% spread over one-month Libor, with a permanent 0.15% increase in the spread, upon the exercise of the fourth extension option. In addition, a Libor cap of 4.0% is in place. Once Libor officially ceases to be produced—on or after June 30, 2023—the index on which this loan is based will likely transition to the Secured Overnight Financing Rate (SOFR). The borrower has exercised four of its extension options, most recently extending the maturity date to March 2024. The loan documents also stipulate that the borrower maintains an interest rate cap agreement with a strike price equal to the greater of (1) 4.00% and (2) the amount that would result in a debt service coverage ratio (DSCR) no less than 1.10 times (x).

The largest tenant at the property is United Airlines, Inc. (United), which represents approximately 21.0% of the office net rentable area (NRA) and 18.9% of the total NRA as of the January 2023 rent roll. The property’s overall occupancy rate declined from 91.9% at YE2020 to 86.0% as of YE2021, after United terminated its lease on 157,000 sf (three floors) of space. As part of the early termination, United paid a one-time termination fee of $26.7 million that, according to the loan documents, the borrower was not required to remit to the lender, given the loan was not in a trigger period. The subject property serves as United’s headquarters with its current in-place lease scheduled to expire in March 2033, not including two five-year or 10-year extension options. United had an option to terminate its lease effective December 31, 2023, with 24 months’ notice and the payment of a termination fee; however, this option was not exercised.

The January 2023 rent roll indicates occupancy has dropped to 82.3%; however, future leases totaling 4.3% of NRA have been signed at the property with start dates between July 2023 and January 2025. The remaining tenancy is relatively granular, with no other top five office tenant representing more than 5.0% of total NRA. According to the YE2022 financial reporting, the property generated net cash flow (NCF) of $79.5 million with a DSCR of 2.05x compared with the YE2021 figures of $81.5 million and 4.09x, respectively. The YE2021 and YE2022 NCF figures are 3.5% and 5.9% lower than the DBRS Morningstar NCF figure of $84.5 million, which was derived in 2020 when ratings were assigned. The decline in the loan’s DSCR can be attributed to rising interest rates, which resulted in a 94.6% increase in debt service obligations between YE2021 and YE2022. According to Q4 2022 Reis data, the West Loop submarket had an average vacancy rate of 11.8%, relatively in line with the subject’s vacancy rate of 11.2% (for the office segment). The West Loop submarket’s vacancy rate is projected to remain elevated, at above 11.0%, through to 2027. Should United opt to vacate any more space, the borrower could face headwinds in finding replacement tenants, particularly as the fully extended loan maturity date in March 2025 coincides with a still-elevated vacancy rate in the submarket.

In its analysis for this review, DBRS Morningstar used a NCF of $77.9 million, which was derived by applying a 2.0% haircut to the YE2022 NCF. A 7.25% cap rate was applied to that value, resulting in a DBRS Morningstar value of $1.2 billion (including $144.7 million of value attributed to the stabilization of the retail and Skydeck components and outstanding office stabilization costs in conjunction with a 75.0% credit applied to the sponsor guarantees). The updated DBRS Morningstar value is a -6.9% variance from the value derived in March 2020 during the North American Single-Asset/Single-Borrower Methodology update, a -31.5% variance from the appraised as-is value at issuance of $1.78 billion, and a -50.0% variance from the projected as-stabilized value for the property of $2.44 billion. The DBRS Morningstar value implies a loan-to-value ratio (LTV) of 108.6% compared with LTV of 74.4% on the as-is appraised value at issuance and the LTV of 54.2% on the projected as-stabilized value.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
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 (May 17, 2022).

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 (March 16, 2023; https://www.dbrsmorningstar.com/research/410912).

Other methodologies referenced in this transaction are listed at the end of this press release.

The DBRS Morningstar rating assigned to Class B is higher than the results implied by the LTV Sizing Benchmark. The analysis for this review considered a stressed scenario to reflect the in-place cash flow declines in recent years; however, given the steady tourist traffic to Chicago that supports the subject’s amenities and the new leases signed that will boost the office portion’s occupancy rate within the next few years, cash flows could stabilize in the near to moderate term, warranting the variance for Class B.

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 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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

North American Single-Asset/Single-Borrower Ratings Methodology (February 23, 2023)
https://www.dbrsmorningstar.com/research/410191

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 12, 2022)
https://www.dbrsmorningstar.com/research/402646

North American Commercial Mortgage Servicer Rankings (September 8, 2022)
https://www.dbrsmorningstar.com/research/402499

Interest Rate Stresses for U.S. Structured Finance Transactions (August 30, 2022)
https://www.dbrsmorningstar.com/research/402153

Legal Criteria for U.S. Structured Finance (December 7, 2022)
https://www.dbrsmorningstar.com/research/407008

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