Then in November, two of the largest loans securitized in 2008 CMBS transactions went to special servicing. Those loans included a $209 million loan for two Westin hotels in Tucson, Ariz. and Hilton Head, S.C.; and a $125.2 million loan for the Promenade Shops at Dos Lagos, a shopping center in Corona, Calif. In both cases, borrowers cited market deterioration as their reason for falling behind on payments.

Investors should expect some delinquencies in a recession, says Woodwell of the MBA, but put that knowledge in perspective. The rate is still well below its peak of 2.72%, set at the end of 2003. “In some ways, that's what the bond structure was designed to deal with,” Woodwell says of delinquent loans. “The high-rated tranches [of CMBS], even when we run them through severe recession scenarios, are still looking good.”

The third problem for the CMBS market is issuance, or the lack thereof. The market is at a seven-month standstill that capped issuance at $12.1 billion in 2008, down more than 90% from the $230 billion that the sector issued in 2007. Don't expect new CMBS transactions in 2009 either, says Sublett of KeyBank. “Probably the earliest we would see any kind of meaningful origination would be in 2011.”

That deprives the commercial real estate market of a much-needed source of leverage. CMBS lenders had become the chief source of commercial real estate financing in recent years — accounting for about one-third of all activity — so shutting off that source of leverage creates a severe undersupply of credit.

Other loan providers, including pension funds, life insurers and banks, may be reluctant to take on new borrowers when much of their capital will be required to finance the maturing loans of their existing customers.

The issuance problem won't be resolved before bond prices recover some of their lost ground, analysts say, because today's CMBS spreads virtually preclude the creation of new loans.

Lenders would have to charge interest rates in the teens to support current bond yield requirements, according to Lisa Pendergast, managing director at RBS Real Estate Finance. That wouldn't leave enough loan proceeds for most borrowers to pay off their maturing loans.

Confident strides

The CMBS market can begin to recover when investors believe the commercial real estate sector has reached the bottom of its cycle, experts say. The signals that will bring about new bond purchases will be a general feeling that property values have bottomed out, that tenants have completed any layoffs and downsizing, and that the economy has stopped shrinking.

Confidence will help buyers and sellers reign in risk spreads to a point that is still attractive to investors, yet low enough to draw in borrowers with cost-effective lending rates.

The confidence of lenders and investors will take months, perhaps years, to be restored, however. In the meantime, industry advocates are working to speed things along. Last fall, the Commercial Mortgage Securities Association, the MBA and 10 other trade groups began lobbying for federal assistance to encourage investment in CMBS.

Specifically, the groups want the sector included in the new Term Asset-Backed Securities Loan Facility (TALF), created in November 2008 and structured to lend up to $200 billion of Federal Reserve money to buyers of AAA-rated securities.

For now, TALF is limited to securities backed by student loans, auto loans, credit card debt and small business loans, and will use $20 billion from the Troubled Asset Relief Program (TARP) to provide credit protection for the loans.