By Todd McNeil
The year 2011 has come and gone. The Commercial Real Estate Finance Markets have had a wild ride. A look at the end of this year gives a different picture than what we imagined at the beginning of the year. The year 2011 began with great promise and some thought a sense of normalcy was coming back to the capital markets. This feeling carried on through the end of the second quarter as the CMBS lenders came back into the market in full force providing much needed liquidity. Class A assets were trading at premiums and there was no shortage of life companies, foreign banks and CMBS lenders bidding aggressively for these loans. The CMBS lenders were funding deals in secondary and even some tertiary markets. Many thought that we had a fully functioning real estate market with prediction of $40 billion to $60 billion of securitization expected for 2011.
As the summer’s heat began to swelter and drought set in over many parts of the country, S&P decided to downgrade the U.S. sovereign debt rating. Europe also had huge cracks showing up in various member countries’ sovereign debt. With this as a backdrop and a seemingly accelerated CMBS market, investors were spooked into thinking that CMBS underwriting had once again slipped into a mode of carelessness and aggressiveness. By the summer’s end the spreads of CMBS loans had ballooned to over 400bps over 10 year swaps. This effectively priced the CMBS lenders out of the market, which is probably what they wanted so that everyone could take a minute to assess where investor’s appetites were for buying CMBS bonds.
As varied options for long-term fixed-rate mortgages tightened, the life companies had a smorgasbord of high quality, low leverage loan opportunities float by their desks and the “rush” for the loans absorbed the major portion of life company 2011 allocations by early summer. Meanwhile, many banks were still working through toxic assets on their balance sheets. The clarity everyone thought was returning to the markets had now turned into a thick fog.
The duration of the third quarter was rife with speculation and doubts on the long-term viability of CMBS, a major cog in the liquidity wheel that is needed to handle the wave of upcoming refinances that are going to hit the market in 2012. The blowout in spreads increased funding costs for CMBS lenders. As Q3 ended, pricing was narrowing on CMBS and many lenders were back in the market actively quoting loans, albeit at a spread level that was yielding around a 6% coupon. While not the worst money available, it is still every bit of 350+ spread over the corresponding pricing index (swaps or treasuries).
The fourth quarter saw a steady stream of consistency from the CMBS lenders at consistent conservative underwriting, 6% +/- interest rates, with amortizations maxing at 30 years. Loan-to-values on commercial properties were advertised as maxing out at 70%, with multi-family properties able to secure 75% loan-to-value underwriting. However, the CMBS lenders have been non-competitive with any property that FNMA/Freddie Mac and HUD get their teeth into. Debt yields, while still around, are fading into the background of a major underwriting hurdle. If your property can handle this type of underwriting, the window was open to secure long-term fixed-rate non-recourse financing.
Despite this pullback in CMBS activity the volume continued to increase and is expected to end the year at around $32.7 billion according to Commercial Mortgage Alert, a significant improvement from 2010’s $11.6 billion total.
For 2012, expect that the lenders in the market will continue to be disciplined; however, production pipelines will steadily increase. Conservative underwriting will continue, with cash flow and trailing 12 operating income carefully scrutinized to derive the amount a lender will be willing to lend against commercial real estate. As long as the underwriting is disciplined there seems to be an appetite for securitization in 2012. Thus, the commercial property finance markets will continue to recover and strengthen as we move forward. Now all the eyes appear to be looking at another round of budget cuts in the United States and a never-ending Europe debt saga before anyone will say we are out of the woods.
Stay tuned, 2012 is right around the corner…..