Archive for category Commercial Real Estate News
Will Commercial Real Estate Provide a Good Hedge Against Inflation?
Posted by Tom Smith in Commercial Real Estate News on April 13, 2011
It seems to be only a matter of time before higher inflation makes its way into official U.S. figures. Countries like Brazil and China are already struggling with it, and even countries with unused capacity like the United Kingdom have to deal with faster than expected price increases.
Food prices are spiking, and the price of oil had been inching upward even before unrest in the Middle East sparked fears of shortages.
Moody’s Economy.com predicts that the headline Consumer Price Index, which counts food and energy prices, will rise at a relatively modest rate of approximately 2% per year in 2011 and 2012, up from 1.6% in 2010.
But when Wal-Mart CEO Bill Simon warns that “inflation is going to be serious,” citing “cost increases that are coming through at a rapid rate,”1 it seems prudent to add a percentage point or so to inflation forecasts and pick investments accordingly.
Standard textbooks say that commercial real estate offers a good hedge against inflation. Will this hold true given the current environment?
The Basis Of Received Wisdom
When the returns from investing in an asset exceed the rate of inflation, it is considered to be a good hedge. In the 1980s, a slew of papers2 examined the rate of return on various property types and concluded that commercial real estate investors were in fact compensated for inflation risk.
Indeed, The National Council of Real Estate Investment Fiduciaries’ total return index, which attempts to capture the gain from both net operating income as well as increases in asset value, generally posted higher returns than inflation in most of the 1980s. The index tracks a large pool of institutional quality commercial real estate held mostly by pension funds.
But what happened in the early 1990s? Shortage in credit from the savings and loan crisis resulted in a sharp dip in commercial real estate income and values. It wasn’t until the mid-1990s that the asset class began posting returns above inflation.
Expect 2011 To Be A Robust Year
The key issue therefore is what determines returns from commercial real estate. With the unemployment rate expected to remain high for another few years, Reis projects only a measured increase in the demand for space.
Income returns have begun to rise from the troughs of 2009 as occupancies and rent growth stabilized, but property types are recovering at different rates.
Read the rest of this excellent article by Victor Calanog, head of research and economics for New York-based research firm Reis.
2011 Brings a Resurgent CMBS Market, More CRE Liquidity
Posted by Tom Smith in Commercial Real Estate News on February 26, 2011
However, Specter of Cheap Money Backing Questionable Deals Still Haunts Industry Shaken by Recession
CMBS activity has flourished in the past few weeks with more than $6.5 billion in new securitization coming to market. In addition, Freddie Mac brought two multifamily-backed offerings totaling $1.86 billion to market.
The activity in February alone is almost two-thirds of all CMBS deals offered last year – and for some is reminiscent of 2007 when commercial mortgage-backed securities offerings were at their peak, which has the commercial real estate market bullish and fretful at the same time.
Pictured on the right: The Christiana Mall in Newark, DE, backs the largest loan in Morgan Stanley’s latest CMBS deal.
On the one hand, the volume in CMBS loan origination is another welcome sign that liquidity has returned to the markets. However, relatively large amount in a short period of time is also raising apprehensions that the still frail health of general commercial real estate is being unduly sustained by perhaps overly eager lenders.
“I think it is clear that CMBS is coming back — something that is probably positive in the short-term as far as jump-starting the investment marketplace and helping to establish a new baseline for pricing while, hopefully, alleviating some of the distress issues out there. But is it a good thing in the long run?” Garrick Brown, Northern California research director of Cassidy Turley BT Commercial asked.
“I have serious concerns as to whether we have learned the lessons of the past,” Brown answered. “The fact is that too much capital chasing too few assets is one of the factors that helped to create a commercial real estate investment bubble in the first place. I suppose I may be old school, but the problem I see is that the stock market was always about higher levels of risk and reward, but commercial real estate was the safe and stable alternative. Yet, as we saw during the last cycle, injecting Wall Street via CMBS offerings into the commercial real estate market didn’t do much to improve CRE returns but certainly sent the risk through the roof.”
Robb Barnum, CFA, vice president structured and quantitative research at Conning & Co., an asset management firm in Hartford, CT, added that, “Contrary to the thinking a year ago or so that [the CMBS deals] would be much better this time around, I don’t think the new deals are tremendous. Just look at the new [J.P. Morgan Chase Commercial Mortgage Securities Trust 2011-C3] deal. Though underwritten with lower LTV [loan-to-value] and higher DSCR [debt service coverage ratios], it doesn’t mean it’s a good conduit deal. Over half the properties are in secondary or tertiary markets. Almost two-thirds is retail. 15% is a Class B mall in a secondary market. Given how much CMBS spreads in general have marched in, the market seems over bought to me.”
Rush To Fill the Void
While there is no real count of the number of financial institutions jumping in to CMBS loan origination, Marcus J. Mollmann, president of Reliquid, a Greenwood Village, CO-based online network that connects CRE capital seekers with CRE capital providers, said he is seeing fresh interest from originators this year.
“CMBS originators are broadening their lending criteria as the market stabilizes, capturing quality loans just outside the comfort zone of the larger insurance companies,” Mollmann said. “This has filled an attractive void in the CRE capital market, with CMBS originators picking up quality loans with strong risk adjusted yields and owners again finding a non-recourse option at higher loan-to-value ratios.”
And as the number of originators increases, so too is it likely that the number of CMBS issuances is likely to grow. That also means the competition to loan will grow, which could be a double-edged sword.
“As the number of participants in CMBS lending continues to increase, the competition to originate loans eligible for new CMBS deals will be fierce,” said John O’Callahan, capital markets strategist for CoStar Group. “Insurance companies, GSEs [government sponsored enterprises], and even the healthier large banks will lend on the best properties in desirable markets, while CMBS originators will compete among themselves for the leftovers. They will have to cast a wider net across all markets to garner the volumes anticipated in 2011.”
In fact, O’Callahan said CMBS origination statistics reveal that approximately 85% of origination volume in the second half of 2010 was outside of the most popular markets. And most CMBS volume financed retail properties (55% by volume), with office a distant second (27%).
“CMBS originators are clearly unable to compete effectively with the GSEs, insurance companies, or banks for apartment loans, and the supply of eligible hotel and warehouse loans remains muted,” O’Callahan said. “In 2011, CMBS originators will likely face even stiffer competition for high-quality loans, which will force issuers to push the quality envelope until investors or ratings agencies push back.”
A slight decrease in quality is already visible in pool average underwriting parameters in one of the first deals to market in 2011, O’Callahan noted. In 2010, pool weighted-average LTV and DSCR were better than 60% and 1.65, respectively, and relatively few loans had debt yields lower than 10%. But an initial 2011 deal has a 62% LTV, a 1.49 DSCR, and includes a larger number of loans with single-digit debt yields. The number of interest-only loans is also creeping up, from approximately 12% of the total in 2010 to 20% in 2011.
Outlook for 2011
CoStar’s prediction for CMBS volume this year of around $25 billion on a conservative basis is at the low end of the estimates thrown around by others on Wall Street. CoStar also noted that there could be another $5 billion or so of new issuance coming from “unanticipated” sources.
Not everyone is enamored with CMBS loans either, which could hold back CMBS activity.
“There is debt available from private lenders and it’s not garden variety financing,” said Chris Germain, president of Piping Rock Partners, an investment firm in San Francisco. “We just financed the purchase of a 120-unit Class B-, value-add apartment property (1993 construction) at 90% loan to cost with a first and second mortgage from the same lender–the first was 10 years fixed under 5% and the second was 3-year I/O under 4%, both are fully pre-payable.”
“It was a bit of an unusual situation, but on top of being optimized/customized for our needs, (the loan) was much easier to close than a CMBS deal, which can be checklist-driven nightmares for a borrower,” Germain said. “This deal was also done in a small, tertiary market in the Midwest, where there is still limited capital available.”
“Perhaps my anecdotal experience is an indication that more small and regional banks are returning to the market, which could then mean that CMBS volumes will take a very long time to recover,” Germain said. “On top of the regulatory issues, CMBS deals are a pain in the neck to close, and if you can get a cheaper/better deal from a local bank that’s easier to close, why not do it?”
Jones Lang LaSalle is one of those among the more optimistic with regard to CMBS prospects. In its 2011 Commercial Real Estate Financing Outlook, the firm said total issuance in 2011 is expected to top $40 billion, providing added liquidity to owners with maturing loans to refinance.
“We’re far closer to that fully functioning debt market than we’ve seen since the recession,” said Tom Fish, co-head and executive managing director of Jones Lang LaSalle’s Real Estate Investment Banking practice. “Given the financing spigot temporarily turned off, a natural evolution occurred last year in which lenders returned to safe lending-targeting only low-leveraged, trophy assets. Now, demand has begun to exceed supply, and lenders are moving more aggressively to place capital. In the following months, we expect to see lenders move increasingly up the risk continuum as we’re still in a low overall yield environment, and there’s a high demand for yield generation.”
Jeffrey Berenbaum, Citigroup’s head of CMBS research, told CoStar Group that his outlook falls in between.
“We are expecting new issuance to be in the $30 billion to $40 billion range. While this is a huge improvement from the $9.8 billion issued in 2010, it is likely not enough to jump-start the investment market by itself,” Berenbaum said. “However, there are many other sources of real estate debt capital, such as life insurance companies, banks, REITS, and hedge funds. Thus, debt capital is far more abundant now than it was just a year ago and is available at a relatively low cost due to increased competition among lenders.”
“Additionally,” Berenbaum said, “borrowers are able to obtain much higher leverage (up to 90% in some cases) as mezzanine/subordinate debt has returned to the market. So we think the revival of the CMBS market will certainly contribute to an investment market revival, but that the other factors mentioned above will also play an important role in the revival of investment market.”
Berenbaum said he does not think the market is “over-exuberant” yet.
“With over a trillion dollars of commercial real estate loans maturing over the next few years, there is still far more demand for debt capital than is currently available. And so long as this exists, lenders will be able to selectively fund the better assets,” he said. “However, a concern is that fierce competition to lend on the best assets could lead to erosion in underwriting standards.”
“It’s also important to keep in mind that a $30 billion to $40 billion market is very small when compared to the mid 2000s,” Berenbaum said. “Overall, the credit quality of the new issue collateral remains very strong compared to the 2005-2007 peak of market originations. While this creates some bifurcation between new issue and legacy classes lower in the capital stack, there is minimal difference in credit quality at the super-senior level.”
The Stage is Set
While investors have returned to market and are beginning to look outside of a handful of major markets and the best trophy properties, lenders have been able to come back in slowly with more confidence in the quality of projects.
“This is very healthy and when you think of it,” said Michael Federle, senior vice president of NorthMarq Capital Inc. in San Francisco. “We needed to retract to a slower and more discerning level because the abuses were rampant and it shook up the whole world. The flow of capital is supporting an enormous industry and everyone needs real estate in one fashion or another. Bringing the industry to its knees wasn’t planned and let’s face it, over aggression criminality was wide spread.”
But Federle added, “now that we have better understood the ways that the system got gamed, we can rein it in and have a higher quality of reliable capital flows. It needs to grow slowly at first but with huge stacks of money needing to be redeployed and to provide higher returns to investors and the resultant distribution into the pension world, orderly growth will occur bringing confidence and predictability back into our world.”
Joe Strain, President, ISHC Hotel Realty Advisors Inc. in Dallas, pointed out that just because lending is moving beyond trophy properties, doesn’t mean it is moving into junk properties.
“When you consider less than the best but still very good sponsors with great properties in strong locations, albeit perhaps with some weakness in income history or low temporary occupancy but high potential, demand across all CRE types for these highest two tiers could easily exceed the suggested issuance ranges,” Strain said. “The stage is set and momentum rising for lending standards to open to a wider range of property types and quality tiers-just as buyers will begin to search for next-to-best deals when the best are priced too high for them.”
“None of this would matter if it weren’t for the core compelling advantages of a CMBS loan: off-put risk to the primary lender, lower interest rates and non-recourse liability (if that feature remains) for the borrower,” Strain said. “Now we just have to figure out how not to let lender competition create crazy money CMBS loans written on future incomes or it will be, as has been so very well put, deja vu all over again.”
The Latest CMBS Deals To Come to Market
DBUBS 2011-LC1 Commercial Mortgage Pass-Through Certificates
$2.18 billion
47 loans; 83 properties: retail (43.7%), office (39.5%), lodging (6.8 %), mixed-use (5.9%).
The loans were originated by German American Capital Corp., UBS Real Estate Securities and Ladder Capital.
Largest loan: $234.5 million; Kenwood Towne Centre is a 1.16 million-square-foot regional mall in Cincinnati, OH. The property is anchored by Dillard’s, Macy’s and Nordstrom and features more than 140 in-line tenants and kiosks. The total collateral size is 756,412 square feet as Macy’s and Nordstrom own both the store and land underneath the improvements. The loan is sponsored by General Growth Properties Inc. and The Teachers Retirement System of the State of Illinois.
J.P. Morgan Chase Commercial Mortgage Securities Trust 2011-C3
$1.49 billion
45 loans; 109 properties: retail (62.8%), office (24.8%), lodging (6%).
The loans were originated by JPMorgan Chase Bank.
Largest loan: $215 million; Holyoke Mall is a 1.56 million-square-foot regional mall in Holyoke, MA. The property was constructed in 1979 and expanded and renovated in 1995. The mall is anchored by a Macy’s, Sears, Target, and J.C. Penney and features three additional tenants occupying more than 50,000 square feet that include Burlington Coat Factory, Forever 21, and Best Buy. The total collateral size is 1.36 million square feet, as Macy’s owns both the store and land. The loan is sponsored by The Pyramid Cos.
Morgan Stanley Capital I Trust 2011-C1
$1.55 billion
37 loans; 79 properties: retail (43.6%), office (28.1%), lodging (9.8%), industrial (7.7%), self storage (5.9%), mixed use (4.9%).
The loans were originated by Morgan Stanley Mortgage Capital Holdings and Banc of America Mortgage Capital Corp.
Largest loan: $235 million; Christiana Mall is a 1.1 million-square-foot enclosed super-regional shopping mall in Newark, DE. The property was originally constructed in 1978, expanded in 1990, and is currently in the final stages of a $187.5 million renovation and expansion. The expansion included the construction of a wing that features a new food court, restaurant space, a Target, and a Nordstrom. Nordstrom is expected to open in April 2011. The mall has four anchor tenants, Macy’s, JCPenney, Target, and Nordstrom, and one major tenant, Barnes & Noble. The mall has 129 retail tenants. The loan is sponsored by Prime Property Fund and General Growth Properties.
WF-RBS Commercial Mortgage Trust 2011-C2
$1.3 billion
50 loans; 96 properties: retail (52.1%), office (15.7%), mixed use (11.8%), industrial (6.1%), land (5.5%), self storage (4.5%).
The loans were originated by Wells Fargo Bank, Royal Bank of Scotland, Natixis and Basis.
Largest loan: $168.1 million; Hollywood and Highland is a 458,686-square-foot retail/entertainment center at the corner of Hollywood Boulevard and Highland Avenue in Los Angeles, CA. Built in 1999-2001, the center includes 161,058 square feet of retail shops, 25 restaurants/eateries, two nightclubs, one multi-screen cinema, a large event theater (the Kodak Theatre), a grand ballroom, billboards, and a bowling alley. The property is considered to be an area landmark and tourist attraction due to its 696 feet of frontage along the Walk of Fame. The loan is sponsored by CIM Group.
Freddie Mac Structured Pass-Through Certificates, Series K-010
$1 billion
76 loans; 81 multifamily properties
The loans were originated by: Beech Street Capital, Bellwether Real Estate Capital, Berkadia Commercial Mortgage, CBRE Capital Markets, Centerline Mortgage Partners, CWCapital, Deutsche Bank Berkshire Mortgage, Financial Federal Savings Bank, Grandbridge Real Estate Capital, HFF LP, KeyCorp Real Estate Capital Markets, M&I Marshall & Ilsley Bank, NorthMarq Capital, Primary Capital Advisors, The Community Preservation Corp., Walker & Dunlop and Wells Fargo Bank
Largest loan: $133.36 million; East Coast 6 is a 499-unit apartment complex in Long Island City, NY, built in 2006. The loan is sponsored by Queens West Development Corp. and Rockrose Development.
Freddie Mac Structured Pass-Through Certificates, Series K-701
$861.3 million
44 loans; 44 multifamily properties
The loans were originated by: Berkadia Commercial Mortgage, CBRE Capital Markets, CWCapital, Deutsche Bank Berkshire Mortgage, Grandbridge Real Estate Capital, HFF LP, KeyCorp Real Estate Capital Markets, NorthMarq Capital, PNC Bank, Primary Capital Advisors, Walker & Dunlop and Wells Fargo Bank
Largest loan: $241.5 million; Franklin Park At Greenbelt Station is a 2,877-unit complex in Greenbelt, MD, built in 1963 and renovated in 2009. The loan is sponsored by Fieldstone Properties.
Third-Quarter 2010 Real Estate Investment Outlook
Posted by Tom Smith in Commercial Real Estate News on October 6, 2010
Investors Go On Offense
Improving capital markets spark renewed interest across property types.
Growing confidence in apartments, hotels and even the downtrodden retail sector is helping pull investors off the bench and back into the game. Some 55% of all respondents to a survey conducted by National Real Estate Investor and Marcus & Millichap Real Estate Investment Services believe that now is the time to buy apartments, followed by retail (32%), undeveloped land (29%), hotel and mixed use (26%), and office and industrial (24%).
That enthusiasm is even strong among investors who already own apartment properties, with 70% indicating that now is the time to buy [Figure 2]. Conversely, only 36% of office owners believe now is the time to buy office properties. Apartment owners also are bullish on rents, with 41% anticipating that rents will increase over the next 12 months.
The response to the online survey conducted between July 15 and July 30 – which yielded 529 responses – shows a big boost in confidence compared with a similar survey conducted in the fourth quarter of 2009. Back then, 31% of apartment investors projected an increase in effective rents, and the projected increase averaged a miniscule 0.2%.
Survey Methodology
In mid-March, National Real Estate Investor’s research unit and Marcus & Millichap e-mailed invitations to participate in an online survey to public and private investors and developers of commercial real estate. Specifically studied were Marcus & Millichap clients and subscribers of NREI and Retail Traffic selected from commercial real estate investor, pension fund, and developer business subscribers who provided their e-mail addresses. The majority of respondents are private investors (36%); private partnerships (19%) or developers (16%) with an average of $35.8 million invested in commercial real estate. Real estate investment trusts and institutional investors represent 6% of all respondents.
“There is no question that apartments really scream when it comes to actual performance and renewed investor confidence,” says Hessam Nadji, managing director of research and advisory services at Encino, California-based Marcus & Millichap.
Apartments are identi ied as the best product to buy right now because the property sector is leading the recovery in real estate fundamentals. Nationally, apartment vacancies declined 20 basis points during the first half to reach 7.8%, setting the stage for rent growth of 3% for 2010, according to Marcus & Millichap.
Hotel owners also are exhibiting a surge in con idence, with 39% of respondents projecting a rise in the average daily rate (ADR) in the coming year compared with 34% who expect rates to remain the same, and 25% who predict a decline.
That is a noticeable improvement over fourth-quarter 2009 sentiment when only 7% of hotel owners anticipated an increase, 31% thought ADR would remain the same, and 59% expected a decrease in rates. Hotel owners who predict an increase in ADR in the coming year expect an average rise of 6.4%.
“Those two sectors are far more correlated with the general economy on a more immediate basis because of their short-term leases,” says Nadji. Hotels can change room rates daily, while apartments typically operate with 12-month leases.
Sales activity improves
Although transaction volume is far below normal levels, property sales have increased signi icantly in the past year. Nearly $36.4 billion in commercial real estate properties traded hands during the irst half of 2010. That marks a 40% rise over the $21.7 billion in sales in the first half of 2009. Still, that sum pales by comparison to the $89 billion notched in the first half of 2008.
The volume of property sales during the irst half of 2010 met the expectations of more than half of investors (58%). A closer look at the results shows 20% believe that sales met expectations, 20% think sales met expectations and should continue to improve, and 18% say that sales met expectations but that it’s an anomaly. “It is a little concerning that as much as 18% think that the improvement in sales is temporary and isn’t going to last,” says Nadji. That is a high number, and it is even more worrisome when combined with the 39% who indicate that property sales over the past six months did not meet expectations.
However, that response stems in part from the continued frustration and disappointment in the market over the limited volume of quality properties available for sale and distressed sales, adds Nadji.
On a positive note, the financing spigot is beginning to open up again. One in three respondents (34%) believes that institutional lenders have experienced the biggest improvement in lending volume, followed by commercial banks (28%), and government agencies such as the Federal Housing Authority (19%).
“Financing is beginning to thaw, but it is nowhere near where it needs to be to support normalized sales volume,” emphasizes Nadji. “It is encouraging to see insurance companies and CMBS come back into the market and we expect them to play a bigger role in 2011,” says Bill Hughes, senior vice president and managing director of Marcus & Millichap Capital Corp.
Buyers still skittish
The positive investor sentiment that emerged in the first quarter has held its own despite some major bumps on the road to recovery, including the European debt crisis and slower than expected job growth in the United States.
The majority of respondents (61%) plan to increase their commercial real estate investment in the next 12 months. That sentiment is much the same as the first-quarter survey results when 60% of investors said they planned to expand their holdings.
Respondents have an average of $37.4 million invested in real estate, and respondents who do expect to grow their commercial real estate portfolios anticipate an average increase of 23%.
Although the industry still has a long recovery ahead, the NREI/Marcus & Millichap Investor Sentiment Index also supports the fact that investor confidence has taken a major step forward in the past year.
After reaching a low point of 91 in 2009, the index has been steadily on the rise but remains below the peak of 148 set in 2005. By the third quarter of this year, the index had rebounded to 119. Since 2004, NREI and Marcus & Millichap have been tracking investor plans for changing their commercial real estate holdings, as well as expectations for changes in property values. This information has been compiled to produce the investor sentiment index shown on page 1.
“There is a strong response of investors who want to buy more real estate,” says Nadji. “But we also are stuck in this period of uncertainty and cautiousness.” The European debt crisis shook a fragile global economy and sparked fears that turmoil in Europe may infect the U.S.
Virtually all respondents (96%) expect the European debt crisis to have at least some impact on the U.S. economic recovery. On a scale from 0 to 5 with 5 representing the highest impact, the vast majority (76%) rate the impact as a 3, 4 or 5. Only 20% of respondents rate it as a slight impact at a 2, and 4% report no impact or did not answer the question.
Results of the European bank stress tests were announced July 23. The tests, which were conducted by the Committee of European Banking Supervisors, showed that the majority of banks are on solid footing. Although some critics say that the tests were not strict enough, only seven of the 91 European Banks tested failed the stress test.
“There is an overstated jitteriness in the marketplace, and I think investors are astute to consider the European debt crisis as a problem because it does affect U.S. exports. And exports are a significant contributor to gross domestic product,” says Bill Hughes, senior vice president and managing director of Marcus & Millichap Capital Corp.
The gross domestic product rose 2.4% on an annualized basis in the second quarter, much slower than the 3.7% growth rate achieved during the irst quarter.
Obstacles remain
One of the key stumbling blocks to recovery has been the weak job growth. The private sector added an average of slightly fewer than 100,000 jobs per month during the first half of 2010. In comparison, the U.S. added an average of 186,600 jobs per month during the first half of 2006.
The largest group of respondents (42%) believes that the relatively slow pace of job growth is a reflection of a sluggish recovery, while 33% believe it is a reflection of u ncertainty stemming from issues of taxation and financial regulation [Figure 3].
Another 13% of respondents believe the weak job market is the beginning of a double-dip recession, 5% believe it is a new normal in job creation, and the remaining 7% either had no answer or a different response altogether.
“This economy is clearly slowing and we cannot ignore our long-term issues.” says Nadji. “Once we get past the exaggerated concerns regarding a double dip, and there is more clarity about the direction of the economy, I expect both investor sentiment and sales activity to increase substantially. I think that will happen by the end of the irst quarter in 2011.”
CMBS Revival Marks Step Toward Recovery
Posted by Tom Smith in Commercial Real Estate News on September 24, 2010
This is an interesting article by Lingling Wei over at the Wall Street Journal.
Banks Ramp Up Operations That Bundle Commercial Mortgages Into Bonds in Hunt for Returns, but Risks Remain
J.P. Morgan Chase & Co. has taken an early lead in the race among big banks to revive the business of originating and bundling commercial mortgages into bonds.
Banks including J.P. Morgan, Goldman Sachs Group Inc., Wells Fargo & Co., Bank of America Corp. and Morgan Stanley are ramping up—and in some cases, rebuilding—their commercial-mortgage-backed securities, or CMBS, operations, as investors world-wide increasingly look outside U.S. government bonds for returns. Millions of dollars of fees are on the line, but risks remain with an enormous amount of uncertainty hanging over both the economy and the performance of office buildings, stores, hotels and other commercial real estate.
Wall Street is expected to sell about $10 billion of CMBS this year. That amount pales next to $230 billion of CMBS issuance in 2007, the record year for the market, according to data provider Dealogic. But it still amounts to a sharp turnaround from the past two years, when new deals came to a virtual halt as the CMBS market was swept up by the carnage in the broader credit market.
For the broader commercial real-estate market, the renewal of the CMBS market is a critical step in the road to recovery. Owners and developers have relied on the securities market for the bulk of their financing during the past decade.
For Wall Street, the return of CMBS means a possibly lucrative business, especially now that the market is being tested in the wake of the downturn. The strong demand among bond investors for higher yields has pushed up the profits generated by banks from selling CMBS to between 0.04 and 0.05 percentage point on issuance from about 0.02 percentage point earned during the years between 2006 and 2008, according to bankers, investors and other market participants. In 2007, banks earned $530 million in fees on CMBS issuance.
J.P. Morgan has been leading the pack, with about $3.2 billion in issuance since late last year. Unlike its competitors, which all but shut their CMBS desks, the bank has kept its CMBS operations, led by Brian Baker, relatively intact throughout the downturn.
J.P. Morgan, like other banks, has moved to improve the credit quality of the properties underlying the deals and simplify the structures. Past deals often had more than 10 tranches backed by hundreds of loans. Current deals have fewer loans and tranches.
“The direction is headed towards more attractive investment opportunities for high-grade buyers,” says Mike Moran, a senior real-estate portfolio manager at Allstate Investments, part of insurer Allstate Corp.
J.P. Morgan is expected to sell another $1.2 billion of CMBS issue by the end this month, according to people familiar with the matter. The bank, with Deutsche Bank AG, is near to closing a $2 billion loan that will help a group led by Centerbridge Partners LP, Paulson & Co. and Blackstone Group to finance its $3.9 billion purchase of Extended Stay Inc. out of bankruptcy protection. It is likely that J.P. Morgan will sell part of the loan in another CMBS transaction, people familiar with the matter said.
A J.P. Morgan spokesman declined to comment on pending deals.
The rebounding CMBS market has outshined most other businesses that also depended heavily on securitization, such as credit cards and home mortgages. So far, there has been only one offering of “private-label” securities backed by home loans without government support.
But CMBS borrowers have turned into an exclusive club consisting mostly of owners of properties with steady cash flows and low leverage. Those borrowers are benefiting from great rates. Ten-year CMBS loans now pay between 5% and 5.5% in rates, down from about 6.5% six months ago, according to market specialists.
But investors are well aware that there is a lot of pain still to be felt in commercial property. Rents and occupancies are still weak in many markets. Also, of the $1.4 trillion of commercial-real-estate debt coming due by the end of 2014, roughly 52% is backed by properties that are underwater, according to Trepp LLC, a research firm that tracks the commercial-property market.
“For those who can’t and don’t want to dig into hundreds of potentially underperforming loans packaged into deals issued a few years ago, the clean new-issue stuff sounds like a compelling story,” says Andy Solomon, a managing director in charge of commercial-property debt investments at Angelo, Gordon Co.
The newer deals also are structured in a way that incorporates lessons learned from the recent downturn.
For example, the coming $1.2 billion CMBS deal—backed by about three dozen mortgages on a variety of properties—addresses concerns from holders of investment-grade bonds that the buyers of junior bonds were given too much power.
Entities including MetLife, Inc., TIAA-CREF and BlackRock Inc., the traditional buyers of triple-A bonds, have called for greater rights for senior holders in future CMBS deals, market participants say.
Write to Lingling Wei at lingling.
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