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

DBRS Limited (DBRS Morningstar) confirmed its credit 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 credit rating confirmations reflect DBRS Morningstar’s overall outlook of the transaction, which remains in line with issuance expectations. Although there has been relatively limited seasoning with minimal updates to the financial reporting since the transaction closed in January 2022, the servicer-reported financials for YE2022 and the trailing-12 months (T-12) ended June 30, 2023 reflect stable to improving occupancy, revenue, and net cash flow (NCF) figures as the sponsor works toward achieving its business plan of leasing up 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 $800.0 million primarily consisted of upgrading and reinforcing the existing structure, in addition to constructing an additional 17-story, 304,301-sf glass office tower 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. The transaction sponsorship is a joint venture between CommonWealth Partners LLC and the California Public Employees’ Retirement System, which purchased the property for approximately $1.03 billion ($1,480 per square foot (psf)). Whole loan proceeds of $507.0 million, along with $588.0 million of borrower equity (53.7% of the cost), were used facilitate the acquisition of the property, fund a $35.5 million leasing reserve, a $7.9 million free rent reserve, and cover closing costs. The loan is interest-only (IO) throughout its five-year term with a scheduled maturity date in January 2027.

As of the June 2023 rent roll, the property was 77.7% occupied, unchanged from YE2022, but higher than the issuance figure of 72.7%. There has been positive leasing momentum at the property with Sprinklr, a software company based in New York City, signing a lease for 23,623 sf that is scheduled to commence in Q2 2024, implying the physical occupancy rate at the property will increase to 81.1% in the near term. According to Reis, the Penn Station submarket reported a Q3 2023 vacancy rate of 7.8% with an average asking rental rate of $80 psf, compared with the subject’s in-place rate of $100 psf. FZN US Platform Co Inc. (FZN) (5.1% of the net rentable area (NRA); lease expiration in June 2034) and Fireblocks, Inc (1.4% of the NRA; lease expiration in September 2025) signed new leases in 2022, with initial rates of $174 psf and $122 psf, respectively. FZN received 20 months of rent abatements that are scheduled to expire in June 2024, suggesting the property’s average rental rate will likely continue to trend upward.

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 when 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 when 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. Peloton listed approximately 100,000 sf of its space for sublease as the fitness company looks to downsize its physical footprint. Both tenants have invested significantly in 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. In addition, the loan is structured with strong cash sweep provisions should Peloton or Lyft choose to exercise their early termination options.

According to the T-12 months ended June 30, 2023 financial reporting, the property generated NCF of $27.5 million (a debt service coverage ratio (DSCR) of 1.52 times (x)), an improvement from the YE2022 figure of $26.5 million (a DSCR of 1.46x) but below DBRS Morningstar’s stabilized NCF derived at issuance of $40.0 million (a DSCR of 1.53x). While the collateral has yet to stabilize and the physical vacancy rate remains elevated, tenant abatements have yet to burn off and the sponsor continues to work toward its business plan of leasing-up vacant space. To achieve the DBRS Morningstar stabilized occupancy rate of 92.5%, management needs to lease-up approximately 130,000 sf at a total cost of approximately $21.6 million ($166 psf) based on DBRS Morningstar’s tenant improvement and leasing assumptions at issuance, which is below the remaining $27.3 million of reserves dedicated to accretive leasing costs.

Despite the generally challenging economic conditions, coupled with the adoption of remote and hybrid work, that continues to place downward pressure on the office sector, the property benefits from its superior quality, strong institutional sponsorship, its location in a premier New York office market, and the lack of significant rollover risk during the five-year loan term. In addition, the loan includes strong structural features including, but not limited to, upfront reserves and cash management provisions. DBRS Morningstar’s ratings are based on a value analysis completed at issuance that considered a capitalization rate of 6.5% which was applied to the DBRS Morningstar NCF of $40.0 million, resulting in a DBRS Morningstar value of $616.1 million and a whole loan-to-value ratio (LTV) of 82.3%. The DBRS Morningstar value represents a 40.8% haircut to the appraiser’s value of $1.0 billion. 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 30.0% below the $1,146 psf invested by the seller to gut renovate the property. DBRS Morningstar maintained positive qualitative adjustments to the LTV sizing benchmarks totaling 3.75% to account for low cash flow volatility, strong property quality, and market fundamentals.

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/416784 (July 4, 2023).

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 credit ratings are subject to surveillance, which could result in credit 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 the 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 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 credit rating was initiated at the request of the rated entity.

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

This is a solicited credit rating.

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

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

The credit 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 (October 19, 2023; https://www.dbrsmorningstar.com/research/422174)

Rating North American CMBS Interest-Only Certificates (December 19, 2022; https://www.dbrsmorningstar.com/research/407577)

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023; https://www.dbrsmorningstar.com/research/420982)

North American Commercial Mortgage Servicer Rankings (August 23, 2023; https://www.dbrsmorningstar.com/research/419592)

Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023; https://www.dbrsmorningstar.com/research/415687)

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

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/417279.

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