While not even on the menu six months ago, the market for commercial mortgage-backed securities (CMBS) has become a front-burner entrée as lenders finally have all the ingredients for making new loans. According to “Mastering the Recipe,” the latest podcast produced by John B. Levy & Co., commercial real estate lenders continue to search for the right mix of leverage level and loan pricing as they try to bring a tepid secondary market to a simmer.
“After groping around in the dark for the right combination of ingredients, commercial lenders just might have found the right recipe for exciting the current market,” says John Levy, founder of John B. Levy & Co. “And this is happening as the Federal government — through the TALF program — seems to be backing away from helping private enterprise, both for the commercial and the single-family markets,” Levy adds. “Interestingly, only one of the three CMBS deals completed last year came through TALF, and this program expires shortly.”
As the TALF program comes off the lending menu, the market is seeing an uptick in the number of borrowers who have decided to access mezzanine debt. Today, rates for mezzanine debt fall in a range between 10% and 13%, a collapse from the 15% to 20% range of six months ago. These lower rates give borrowers additional leverage. Investors need either more equity, which they are now able to raise, or they need mezzanine debt because their existing borrowings cannot be replaced by a new first mortgage.
“The surge in the Dow certainly isn’t hurting matters,” says Levy. “A year ago, we were at around 6,500, and the banking system was on the verge of collapse. Today, the Dow is approaching 11,000. The banking system is starting to be profitable again, and people are paying off their TARP loans. It’s understandable that people look at the Dow and feel confidence. And in the financial markets, confidence expresses itself in a willingness among lenders to make new loans.”
But not all is well. Despite the growing confidence that comes from a rising Dow and upbeat loan market, smaller retail and community banks continue to be pruned. Those institutions with an asset base between $100 million and $10 billion that fall in the bottom 5% to 10% of their competitive set are at the greatest risk.
“Loan markets are definitely up,” says Levy. “People are entertaining new investments in the form of loans, preferred equity, mezzanine debt — for all types of property. We’re even finding an active market for shopping centers,” adds Levy, “and that’s after all the talk around the Christmas season that retail was dead. This doesn’t mean we’re running at thoroughbred pace, however. We’re more like the tortoise. But when you consider that we weren’t running at all six months ago, tortoise pace is good.”