When the credit crunch first broke in earnest last fall and froze the U.S. commercial mortgage-backed securities (CMBS) market in its tracks, the most bullish prognosticators predicted a mere blip. Many expected issuance in the U.S. to be down from $237 billion in 2007, but thought it could reach $150 billion. The conservative estimates put the expected 2008 volume at $100 billion.

Today, those worst-case scenarios are looking wildly optimistic.

Through the end of June, U.S. CMBS issuance had reached just $12.1 billion according to Commercial Mortgage Alert, an industry newsletter. Overall, that's a 91 percent drop compared with the first six months of 2007. In June itself, $1.3 billion of CMBS bonds were sold. That was up slightly from the $900 million in May, but down more than 96 percent from the record $37.4 billion in June 2007.

In all, analysts are no longer calling for any kind of rebound this year. Analysts from J.P. Morgan Chase & Co., in fact, expect the second half of 2008 to be even quieter than the first, with full-year CMBS issuance volume totaling $20 billion.

What's the upshot of all this? Since CMBS loans accounted for about 70 percent of all commercial real estate financing in 2007, it means prospective borrowers still have no place to turn and the slowdown in investment sales that has plagued the sector won't be resolved any time soon, according to Sam Chandan, chief economist with REIS, Inc., a New York City-based provider of commercial real estate information.

The fundamental problem is the wild uncertainty within credit markets. CMBS spreads to 10-year Treasuries have not only widened considerably from a year ago, but continue to fluctuate from month to month. As a result, it’s more difficult for borrowers to decide whether or not to take conduit loans. Further, alternative sources of funding, such as banks and life insurance companies, aren't offering the same generous terms CMBS lenders did in the past, nor are they greatly increasing their allocations to commercial real estate. Lending on commercial real estate is down across the board from 2007.

Within the CMBS sector, spreads have begun to widen once again. As of June 25, spreads over Treasuries on five-year, fixed-rate AAA conduit loans stood at 165 basis points, above the 52-week average of 147 basis points, reports Commercial Mortgage Alert. Spreads on 10-year, AA loans were at 475 basis points, above the 52-week average of 370 basis points, and spreads on 10-year BBB loans were at 1,250 basis points, compared to a 52-week average of 931 basis points. For borrowers, those rates are simply too high. Moreover, loans from other sources offer competitive pricing--an area where previously CMBS loans had an edge.

"With spreads as wide as they are, loans that are destined for securitized pools are not as competitive,” Chandan notes. “Investors are demanding extraordinary premiums as opposed to the types of spreads we’ve observed in recent memory.”

With CMBS out of the picture, the retail real estate sector saw a 53 percent drop in overall lending activity in the first quarter of 2008, according to data released last month by the Mortgage Bankers Association (MBA), an industry organization. Commercial bank originations in the commercial/multifamily sector fell 28 percent in the first quarter of the year, according to the MBA, to $228 billion. Originations by life insurance companies decreased 25 percent, to $119 billion.

All of that means that it continues to be difficult to complete investment sales deals on properties that don’t include in-place financing, says Philip D. Voorhees, senior vice president of retail investments with the Newport Beach, Calif.-based office of global brokerage firm CB Richard Ellis. Life insurance companies and regional banks tend to be much more selective in the kinds of properties they will finance, Voorhees notes. The life insurance firms, for example, require that a property feature a location in a major metro market, a vacancy rate lower than 5 percent and credit tenants before agreeing to issue a loan. They also insist on loan-to-value ratios of 60 percent to 65 percent, lower than most investors feel comfortable with.

“They’ve only got so much to lend out and that is drying up. Similarly, the local banks are reportedly approaching capacity,” Voorhees adds. “We lost one of our biggest sources of debt in the conduit market and nobody is there to replace that.”

As a result, the volume of sales transactions closed by Voorhees’ team year-to-date has been about 30 percent off compared to the same period in 2007. Voorhees has some hope the situation will improve by the fourth quarter. But with more than $11 billion worth of securitized loans becoming eligible for refinancing in the next six months, Chandan says it’s not likely.

“There are concerns about limited liquidity in the market,” he says. “We don’t expect to see significant gains in transaction volumes in the summer or early fall.”

--Elaine Misonzhnik