by Brandon Miller, Senior Director
Just over a month ago, our firm posted a blog hailing the arrival of CMBS 2.0 as a welcomed “end of the beginning event”. While the production stats in the CMBS market are way up and more players continue to enter the securitized lending market, we are discovering through our own placement efforts that CMBS 2.0 is by no means a fluid process.
On a macro level, the securitization market continues to be at the mercy of the ongoing turmoil in the broader financial markets. Last week, spreads blew out to the highest level of the year on a $1.2 billion securitization.
On a micro level, the challenges of finding the right CMBS lender, careful underwriting and maximizing financing proceeds have been made even more difficult as loan originators continue to learn what will and will not get done in this evolving CMBS 2.0 world. While the list of CMBS lenders continues to grow in number, the real gatekeepers responsible for the revival of the securitized lending market are the B-piece Buyers (i.e. the investor buying the riskiest portion of a CMBS offering). The list of gatekeepers on the other hand is not nearly as deep as the list of originators. There could be 100 different CMBS lenders but ultimately their offerings will be looked upon by a select number of investors. Because of the limited number of buyers in the market, lenders must remain very much in tune with the appetite of the B-piece buyers or they risk not being able to move loans off their books through the securitization process.
In CMBS 1.0 borrowers, lenders, and intermediaries alike became conditioned to the process. CMBS loans were a commodity like gasoline. If the price was too high at one gas station all you simply had to do was cross the street for a better price. This went for Borrowers looking for a CMBS lender as well as a CMBS lender looking for a B-piece Buyer. At least until the music stopped. The primary goal then was maximizing loan dollars and minimizing the interest rate. Other than that, the prevailing attitude as a Borrower or Intermediary was “don’t ask, don’t tell”. The CMBS market seemed to be running efficiently so why stir the hornets’ nest?
In CMBS 2.0, our firm has learned that you are more likely to get stung by not stirring the hornets’ nest. The CMBS market is far from efficient today and previous experiences in CMBS 1.0 are largely irrelevant. It is important to dive deeper into a deal from the start beyond just underwriting on the property-level. For example: What is the ownership structure? Are there a handful of limited partners or is it a syndication of many limited partners? How much equity is in the deal? Which principals will sign on the carveout requirements? How do those principals look financially? Do they have credit issues? Do those principals have equity in the deal? These all sound like important questions but prior to CMBS 2.0 they held less relevance to the success of a transaction.
Most real estate deals are structured with a Sponsor that serves as a General Partner and provides the expertise in owning, operating and managing the real estate. In many of these cases, the Sponsor lacks one important ingredient – cash – so equity is raised from outside partners to capitalize a deal. Maybe it is one partner or 30 partners but typically they are passive investors that are simply providing the equity and the Sponsor is the steward of that investment. Having multiple limited partners and/or a syndication structure is an issue for CBMS lenders that appears to be boiling to the surface. The concern is that those partners rarely are the ones that are providing loan guarantees, even for non-recourse debt, but they are the ones with the most equity at stake. On the other hand, the Sponsors are providing their signature for the so-called carve out provisions of the non-recourse loan but the Sponsor will likely have very little cash in the deal.
Not having the “correct” answer to any or all of the questions mentioned above is not an automatic disqualification for a CMBS loan, but it is important to address these with the Lender before going under application. Unlike the days of “don’t ask, don’t tell”, full transparency is now critical to the process. The level at which deals are now underwritten and scrutinized means that at some point in the application and closing process, the lender, or its attorney, will uncover potential issues. Anticipating these issues before they are uncovered could save you the risk of the deal falling out as well as time and money.
Want to learn more about this? Feel free to contact Brandon Miller, Senior Director.