Despite the Federal Reserve's seventh rate cut of the year on Aug. 21, and Gross Domestic Product showing almost no growth, commercial mortgages have continued to exhibit surprising strength, according to the Barron's/John B. Levy & Co. National Mortgage Survey of more than 30 market participants. The market for both commercial mortgage-backed securities (CMBS) and whole loans enjoyed low delinquencies and tight spreads.

On the CMBS side, according to Morgan Stanley data, delinquencies on seasoned securities rose by only 0.02% in July — the most recent numbers available — to 1.23% of current loan balances. This figure is only 0.16% above the rolling four-year average of 1.07%, which included the low-delinquency banner years of 1998, 1999 and 2000.

The current economic weakness, which has pushed 10-year Treasury yields down by some 0.625 percentage points in the past 60 days, has lured a number of borrowers into the market and led Wall Street firms to bundle up a growing supply of new loans for sale as securities. According to Pat Corcoran, vice president with J.P. Morgan, CMBS issuance for the year, both domestic and international, will reach a record $82 billion, surpassing the high of $78 billion set in 1998.

Whereas in 1998 practically all of the volume was the result of domestic business, this year international business will account for 20% of the total issuance, or about $17 billion. Meanwhile, U.S. volume is expected to hit $65 billion in 2001.

Fall season to be a busy one

Analysts expected as many as 12 separate CMBS offerings totaling more than $8.5 billion to roll out in September. With the Federal Reserve's rate cut in August, the 90-day London Interbank Offered Rate (LIBOR) — the most commonly used floating-rate index — is now at a low 3.50%, which means that borrowers seeking floating-rate loans can find interest rates in the 5% to 6% range. More than $4 billion in floating-rate CMBS was slated for September.

Rising vacancy rates and falling rents have made first-mortgage lenders dramatically more conservative in their underwriting. This caution has borrowers scrambling to fill the gap between the low loan-to-value financing available from those lenders and the higher leverage called for in borrowers' business plans.

At the same time, the slowing economy has put a squeeze on the returns expected from institutional-grade, real estate ownership. While the current income from properties, generally in the 8% to 8.5% range, seems stable, appreciation has halted, leaving investors on the equity side of real estate searching for other ways to boost their overall returns.

‘Mezz debt’ grows in popularity

Meeting the needs of borrower and equity investor alike is mezzanine debt, unsecured debt that is subordinate to the first mortgage and lets the borrower add significant leverage — to as much as 80% to 85% of a property's value. Although terms vary widely, loans are generally for five years or less. Interest rates may be either fixed or floating, with current rates in the 12% to 15% range.

And though it's clearly debt, the mezzanine field is dominated by real estate equity investors. They deem mezzanine debt less risky than equity investment in real estate, but with the potential of obtaining equity-like returns. Some of the more active names in “mezz debt” include Goldman Sachs, J.P. Morgan, Capital Trust, iStar Financial, Deutsche Bank and Mass Mutual.

Life insurers increased their total dollar volume allocated to commercial real estate by 30% this year. Many life companies report that they will lend up to only 65% of value on office buildings and shopping centers, while keeping the traditional 75% limit for warehouses and apartments. Insurers also noted that they, like their CMBS brethren, noticed a marked increase in the demand for floating-rate loans. Although some insurers still stick purely to the fixed-rate kind, many also now are offering adjustable-rate loans.




John B. Levy is president of John B. Levy & Co. Inc. (www.jblevyco.com), Richmond, Va. © Dow Jones & Co. Inc.

Barron's/John B. Levy & Co. National Mortgage Survey

Selected CMBS Spreads (in basis points, or hundredths of a percentage point)
To 10-year U.S. Treasuries
Rating 09/03/01 07/30/01
AAA 125 - 126 129 - 130
AA 140 - 142 144 - 145
A 155 - 157 159 - 161
BBB 210 - 215 230 - 235
BB 520 - 540 520 - 540


Whole Loans (Interest rates)
Term of Loan Prime Mtge. Range 09/03/01 Prime Mtge. Rate Prime Mtge. Range 07/30/01
5 years 6.45 - 6.50 6.45 6.71 - 6.81
7 years 6.83 - 6.88 6.83 7.10 - 7.20
10 years 6.93 - 6.98 6.93 7.30 - 7.40


For loans of $5 million and up, on amortization schedules of 25-30 years, that can be funded in 60-120 days, with 0-1 point.