Connect CRE Q&A: Special Servicers and Due Diligence with Rich MacAuley

Apr 5, 2024

The term “special servicing” in connection with commercial real estate loans has been making its way into headlines again in recent months.

In addition to determining the most favorable outcome for the loan, special servicers are obligated to conduct a variety of due diligence procedures. EBI Managing Consultant Rich MacAuley spoke with Connect CRE on what to expect.

Q: What are the due diligence and property assessment considerations for special servicers? Do these come into play when a property (or its underlying loan) is transferred to special servicing, when a servicer is considering marketing a property for sale, or both?

A: Special servicers are obligated to complete a Phase I Environmental Site Assessment (ESA) when an asset is turned over to them. The servicers require that the Phase I ESA comes back “clean” and that any environmental issues uncovered during the site assessment are addressed and resolved.

The pursuit of a Property Condition Assessment is  is dependent upon the site itself and the special servicer’s business plan for the asset. By completing a Property Condition Assessment, further information about the site is provided and this can aid in the execution of the special servicer’s business plan.

Q: The last cycle in which special servicers were especially active was the Great Recession. What has changed since then in terms of special servicers’ requirements?

A: I do not believe anything has changed in the requirements for the special servicers for due diligence.

Q: Does EBI anticipate an overall increase in special servicing activity as 2024 proceeds?

A: To date, we’ve seen a moderate increase in requests from special servicers for due diligence. We anticipate an increase in the volume of projects throughout the year based on conversations and experiences our team has had with special servicers, although we don’t anticipate the volume of deals that occurred during the last recession.

Q: One property type that is expected to see an increase in special servicing transfers is office, which in many submarkets has suffered from low visitation even if the property is at or near full occupancy. Does this create its own considerations for property assessments?

A:  Property type turnover to special servicers depends on the economic situation causing the strain on real estate assets. In the past, we’ve seen times of high turnover with hotels and other times when the majority of turnover fell in the retail space.

In 2024, we expect increases in special servicers transactions to be heavier with office buildings. Office tenants aren’t utilizing their spaces in the same capacity. When their leases roll, they’re looking for smaller footprints or, in some cases, they’re looking to forgo office space altogether. These actions stress the financials of the loans in place.

Property type doesn’t dictate the importance of completing a Property Condition Assessment. Having an in-depth Property Condition Report on any asset provides servicers with current and accurate information on the asset and its building systems. This can be vital in helping the servicer execute an appropriate business plan for the asset.

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