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For lenders, understanding the broader market conditions after a hurricane can help to manage risk and maintain portfolio health. This article explores the impacts of hurricanes on rent, vacancy, and net operating income (NOI), and how these factors influence cash flow and credit risk for commercial real estate (CRE) properties. Additionally, we provide insights on identifying distressed loans and monitoring exposure to loss during a storm.

Understanding the broader market conditions after a hurricane

After a hurricane, the broader market conditions can be affected significantly. Rent levels may decrease as tenants seek more affordable housing options or relocate to less affected areas. Vacancy rates can increase due to property damage and residents and businesses being displaced. This, in turn, can lead to a decline in NOI as properties generate less income while still incurring repair and maintenance costs.

For example, properties in markets exposed to Hurricane Harvey experienced lower asking rents, higher vacancy rates, higher operating expenses, and lower NOI in the quarters following the storm¹. These impacts, while not always substantial enough to influence portfolio-level credit risk on their own, are important considerations for lenders, especially in markets or property types facing other challenges.

How these factors can influence cash flow and credit risk for CRE properties 

The changes in rent, vacancy, and NOI directly affect CRE properties’ cash flow. Reduced cash flow can lead to difficulties in meeting debt service obligations, increasing the likelihood of loan defaults. Properties with higher loan-to-value ratios and lower debt-service coverage ratios are particularly vulnerable to these impacts.

Credit risk analysis for properties affected by hurricanes shows that loan quality and insurance coverage significantly influence the change in baseline credit risk. For instance, a property with a hypothetical damage of 40 per cent could see the expected default frequency (EDF) of a healthy loan increase by almost 7 per cent if no insurance coverage is in place². For unhealthy loans, the credit impacts would be much worse, with EDF increasing by about 8 per cent even with insurance coverage and nearly 20 per cent without insurance.

Identifying distressed loans and monitoring exposure

Lenders can use detailed catastrophe models and post-event analytics to identify distressed loans and monitor their exposure to loss during a storm. These tools help assess the likely damage to properties underlying their loans and provide early indications of potential risks before financial stress affects mortgage payments.

For example, real-time hazard footprints and catastrophe models can simulate hundreds of thousands of possible events to provide a view of potential impacts on properties. This information can inform proactive communication with borrowers and internal stakeholders, helping to mitigate risk and manage exposure effectively.

Conclusion

In summary, hurricanes can have significant impacts on rent, vacancy, and NOI, which in turn affect cash flow and credit risk for CRE properties. Lenders can mitigate these risks by anticipating, measuring, and managing hurricane impacts. Proactive risk management and strategic planning can help maintain portfolio health and minimise losses.

Lenders can benefit from staying informed about the evolving climate and insurance landscape to better manage their portfolios. Understanding the potential for loss under different levels of event severity can help align insurance coverage with true risk and inform capital allocation and portfolio strategies.

Read more in the recent case study from Moody’s "Three steps to mitigate hurricane risks in lending portfolios: lessons from Hurricane Milton" for a comprehensive understanding of the strategies discussed.