By Brad Donnell, Senior Director
September and October will see over $5 billion worth of bonds tied to commercial mortgages (CMBS) being offered into the marketplace, bringing total 2011 sales to $25 billion. Investors are pushing back on the flood of bonds by demanding additional yield versus holding U.S. Treasuries. This extra yield increased by 69 basis points since the end of July to the widest level since July 2010. A fortunate rally in the Treasury market has softened the increase somewhat, but the ability to reasonably quote or price deals is almost impossible.
Securitized lenders have pulled back from originations pending the outcome of these sales, which has impacted the ability of borrowers to refinance existing deals. Unfortunately, we have seen this exercise fairly recently. In late 2007, the same type of volatility in the CMBS market opened the exit door for most all CMBS lenders. The inability to price loans and the speed at which loans became liabilities before they could be securitized spelled the end of CMBS 1.0. Back then, it took three years for the market to return. During that same period, banks thought they had hit the lottery and started making loans on performing deals that typically would have been put to bed with a permanent CMBS loan. Next thing they knew, banks were stuffed to the gills with these “performing” loans and could not figure out why they were not moving along when they matured. Worse, when “performing” turned to “non-performing and maturing,” banks found out the dirty little secret that a “recourse loan” really only gets you a return phone call. They then marched all their experienced borrowers out the back door and shot them only to spend the next three years sorting out the mess and now wonder why it is so hard to find good borrowers with no legacy issues.
This leads us to today. The commercial real estate market is clearly at an inflection point. CMBS delinquencies are starting to ebb and for the first time since the 2007 crash, more deals are exiting the distressed stage than are going into them. We have seen a recovery in values and are clearly in the late innings of the current distress cycle. This cycle has not played out the way it did in the early 1990s, when investors were able to buy great core properties for cents on the dollar. This time, the market has recovered very quickly, especially for core properties (and multifamily), allowing lenders to recover a greater percentage of their losses primarily because there really is not any other place to invest in with any degree of return.
The discounts that are currently available are on assets that have property-level challenges, such as leasing or capital needs, or both. And that requires risk taking, which a lot of investors aren’t willing to do right now as the risk profile of most of the investors today is very risk averse. Those around today are typically those who were not active in the frothy market of 2004 – 2007. What the market needs right now are those risk takers the banks recently skewered to help clear the market as these challenged properties are really where the opportunity is today.
So, you have some stabilization of the real estate markets, decent clearing of distressed assets and bankers who are starting to peek out from under the covers. All seems well, yet there is an eerie sense of déjà vu with that CMBS exit door propped wide open at the moment. While there has not been a mad rush for the exit yet, it sure seems like a lot of those lenders are slowly and nonchalantly back-stepping closer to it. Can’t quite figure if this reminds me of late 2007 or the current state of the Big 12, or maybe both, but I am sure I have seen this somewhere before…
Want to learn more? You can contact Brad Donnell, Senior Director by clicking here.