DBRS Finalizes Provisional Ratings on CGGS Commercial Mortgage Trust 2018-WSS

DBRS, Inc. (DBRS) finalized its provisional ratings on the following classes of Commercial Mortgage Pass-Through Certificates, Series 2018-WSS (the Certificates) to be issued by CGGS Commercial Mortgage Trust 2018-WSS:

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

All trends are Stable.

The Class X-CP and Class X-NCP balances are notional.

The $405.0 million trust mortgage loan is secured by the fee interest in a portfolio of 92 economy, extended-stay hotels, totaling 10,978 keys, located in 22 different states across the United States. All the hotels in the portfolio will operate under the WoodSpring Suites flag. Six of the assets currently operate under the Value Place flag, but are expected to be converted by the end of Q1 2018. The 92 collateral assets are being acquired by the sponsor, Brookfield Strategic Real Estate Partners II (Brookfield), as part of a 107 WoodSpring Suites hotel portfolio for a total purchase price of $767.5 million from Lindsay Goldberg. Simultaneously, Choice Hotels International, Inc. (Choice) will acquire the WoodSpring Suites brand from Lindsay Goldberg in a separate transaction for approximately $231.0 million and will then enter into new 20-year franchise agreements with Brookfield for the hotels. Lindsay Goldberg will retain the management platform and will continue to manage the hotels following the acquisition by Brookfield. Brookfield is acquiring the assets as part of a series of private investment funds with over $9.0 billion of capital commitments at its closing in April 2016. Brookfield Asset Management, Inc. and its affiliates have over $155 billion of assets under management around the world. The subject financing totals $530.0 million, with $405.0 million structured as mortgage debt and $125.0 million structured as mezzanine debt. The debt package, along with a $177.3 million equity infusion from Brookfield, will acquire the 92 collateral assets for an allocated purchase price of $707.3 million and cover closing costs. The 15 remaining non-collateral hotels are transitional and will be financed separately. The loan is a two-year floating-rate (one-month LIBOR plus 2.46% per annum) interest-only mortgage loan with five one-year extension options.

The properties are relatively new, having been built between 2003 and 2016. Since 2013, approximately $54.6 million ($4,972 per key) of capital expenditure (capex) has been invested across the collateral portfolio, including $8.9 million in rebranding costs in 2016 and 2017. Since June 2016, 81 of the assets were converted from the Value Place brand to WoodSpring Suites as part of a brand-wide initiative, while five assets represent newly constructed WoodSpring Suites hotels. The rebrand has greatly benefited from the converted assets, despite the level of capital investment associated with conversions being quite low, as 76 assets, reporting full YE2015 and YE2017 financial figures, have experienced a 14.9% increase in revenue per available room (RevPAR) and a 18.6% in net cash flow (NCF). Meanwhile, the unconverted assets have experienced a 3.7% decrease in RevPAR and a 14.4% decrease in NCF over the same period. These six assets are anticipated to benefit from the rebrand; however, more importantly, the portfolio as a whole will benefit from the brand acquisition of the brand by Choice. Being part of the Choice platform will create a brand activation and access to revenue management systems, national customer accounts and its loyalty program. Additionally, the portfolio should be able to push NCF margins through economies of scale, operational efficiencies and savings with online travel agencies. DBRS assessed the overall portfolio quality to be Average based on the site inspections, with all inspected properties deemed to be Average, except for one property with a quality assessment of Average (-). The properties inspected were generally noted to be in good condition and appealing for a low-cost alternative product, as all properties had been recently converted or are of relatively new construction. The recent capex spent across the portfolio will serve to benefit the hotels in the near term to maintain the overall quality of the product, as the portfolio has exhibited consistently higher occupancies, which will expedite the wear and tear on the rooms.

The portfolio is concentrated by property type, as all properties are extended-stay hotels. Hotels have the highest cash flow volatility of all property types because of the relatively short lease/length of stay compared with commercial properties, as well as higher operating leverage. These dynamics can lead to rapidly deteriorating cash flow in a declining market and, with nationwide RevPAR in its eighth consecutive year of growth, relatively easy RevPAR gains appear to be gone. However, the portfolio has experienced substantial gains in RevPAR, increasing 24.9% since 2014, with year-over-year gains being relatively consistent at 7.3% in 2015, 6.9% in 2016 and 8.9% in 2017. Performance is expected to continue in the near term as the benefits of being part of the Choice flag are fully recognized. Furthermore, extended-stay hotels, which have a much more stable cash flow profile than traditional hotels by virtue of offering limited housekeeping services and being limited to essentially non-existent food and beverage outlets, keeping common areas small and not offering more than just basic amenities, the expense ratios of this product type are relatively low. As of YE2017, the portfolio’s NCF margin was 42.0% and has the ability to improve, as various cost synergies are implemented at the properties being part of the Choice platform. NCF margins for extended-stay hotels generally compare very favorably with traditional hotel properties, as high cash flow margins result in lower cash flow volatility, allowing the subject portfolio to withstand greater revenue declines than traditional lodging assets.

The as-is portfolio appraised value is $710.0 million, assuming a bulk sale, based on an applied cap rate of 8.3%, which equates to a relatively low appraised loan-to-value (LTV) ratio of 57.0%. The DBRS-concluded value of $424.8 million ($38,696 per key) represents a significant 40.2% discount to the bulk sale appraised value and results in a DBRS LTV of 95.3%, which is indicative of high-leverage financing; however, the DBRS value is based on a reversionary cap rate of 11.61%, which represents a significant stress over current prevailing market cap rates. Furthermore, the loan’s DBRS Debt Yield and DBRS Term DSCR at 12.2% and 2.32 times, respectively, are moderate considering the portfolio is primarily securitized by secondary suburban extended-stay hotels and the portfolio’s insurable replacement cost of $637.1 million (excluding land value) is substantial higher than the whole loan amount of $530.0 million.

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

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

For more information on this transaction and supporting data, please log into viewpoint.dbrs.com. DBRS will continue to monitor this transaction with periodic updates provided in the DBRS Viewpoint platform.

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

With regard to due diligence services, DBRS was provided with the Form ABS Due Diligence-15E (Form-15E), which contains the description of the information that the third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While DBRS did not require due diligence services outlined in Form-15E, DBRS did use the Data File outlined in the Independent Accountant’s Report in its analysis to determine the ratings.

The principal methodology is the North American Single-Asset/Single-Borrower Methodology, which can be found on dbrs.com under Methodologies. For a list of the Structured Finance related methodologies that may be used during the rating process, please see the DBRS Global Structured Finance Related Methodologies document on www.dbrs.com. 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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

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