A $1.2 billion commercial mortgage-backed securities (CMBS) offering typically doesn't merit major headlines, but this year's bond market is atypical. Consider that in January there was zero CMBS issuance on Wall Street, the first time that's ever occurred in the 20-year history of the market. So when the offering by Morgan Stanley and Bear Stearns sold on Feb. 13, the issue broke a disturbing silence and underscored how bond buyers today are demanding higher yields for perceived higher risks.

The February deal, backed by 82 loans weighted in retail, wooed investors with the widest yield spreads ever offered on CMBS. The largest class of bonds in the highest-rated tranches was priced to yield 235 basis points over 10-year swaps, a benchmark interest rate. Based on interest rates the day of the transaction, bond buyers will earn about 6.7% from those AAA bonds. To put that in perspective, AAA spreads on CMBS averaged just 25 basis points over swaps a year ago.

Record-high yields on the offering helped to overcome a crisis of confidence among reluctant investors over the past several months. Prospective buyers are nervous about buying a bond while market prices are still in flux because the amount they pay today may be higher than a market price to be established next week or next month, says Joseph Caton, managing director of Waterbury, Conn.-based Hartford One Group, a real estate finance consultant and columnist for NREI. “Nobody knows where the bottom of the risk is,” he says. “That's the reason nobody is stepping up to buy bonds.”

Observers expect this year's U.S. CMBS issuance to come in at less than half of last year's all-time high of $233.7 billion volume due partially to weak demand. Another reason is that there is a reduced incentive for the investment banks that syndicate commercial real estate loans to issue new CMBS. The higher yields bond buyers demand today leave issuers with little margin for profit.

For now, however, the greatest barrier to new CMBS deals is pricing, and the pipeline is clogged with $37 billion of securities awaiting pricing in the first quarter. In a chicken-and-egg conundrum, the lack of transactions is robbing dealers of data they need to make the deals.

“The CMBS market always depends on pricing, and when you don't have any benchmarks, it's hard to know what you can sell something at,” explains investment banker John B. Levy, president of John B. Levy & Co.

The slowdown in CMBS buying is more a reflection of investor trepidation over turmoil in financial markets outside commercial real estate than it is an indictment of bond risk, says attorney Joseph Philip Forte. European investors, for example, have virtually stopped buying real estate securities of all types in reaction to subprime losses. “It's the confluence of a lot of crazy different pieces that are making the market uncomfortable,” says Forte, who is a partner at Alston & Bird LLP in New York and a past president of the Commercial Mortgage Securities Association.

A Fitch Ratings report found that CMBS loan performance is as strong as ever, with delinquencies hitting an all-time low of 0.27% in January. Unfortunately, the ongoing repricing of risk puts buyers and sellers at a disadvantage in trying to price real estate or real estate securities.

Even after the Morgan Stanley-Bear Stearns deal, investors have few benchmarks to help determine investment values and risk premiums. “Everyone is waiting for some pricing to establish itself in the market,” Forte says. “Once you have pricing, you can figure out where the value is.”

What will bring the market back up to speed is a consensus on the price of varying degrees of risk, and that means additional CMBS transactions are needed to better establish pricing. The first new CMBS issue of 2008 by itself doesn't suggest that the market is regaining its footing, according to Levy. “We're starting to see a smidgen of hope, but not a lot.”