The slow recovery in the CMBS market got a big boost in the second half of 2012 thanks to more competitive financing rates. The beleaguered financing niche is hoping that momentum will carry over into 2013.
U.S. CMBS issuance hit a post-crisis high of nearly $48.2 billion in 2012. That volume is still a fraction of the volume that occurred at the peak of the market in 2007 when U.S. issuance topped $228 billion. Yet the industry has made significant strides in rejuvenating a sector that virtually ground to a halt in 2008 when the financial crisis hit.
“I am very optimistic about the CMBS business in 2013. I think volumes will grow substantially. You will continue to see high-quality loans, and you will see more capital raised for the B-piece community,” says Anthony Orso, CEO of New York–based Cantor Commercial Real Estate (CCRE). The real estate finance company, an affiliate of Cantor Fitzgerald & Co., completed five securitizations that amounted to $3.1 billion in 2012 and originated a total of nearly $5 billion in 2012.
Steady growth in issuance is proof that both CMBS lenders and bond buyers are returning to the market. In particular, a resurgence in aggressive bond buying helped to spark an essential contraction in rates in the past year.
“Rates have come way down, and that is going to have a positive impact in 2013,” says Jeffrey Weidell, president of NorthMarq Capital in San Francisco. The financial intermediary originated $962 million in CMBS loans in 2012 across its 30 offices in the United States. That volume is more than twice the volume that the firm originated in 2011, and Weidell anticipates more growth ahead in the coming year.
Underlying the resurgence on the borrower side is the fact that there are investors seeking CMBS bonds, which is being driven in large part by the improving real estate market. Property values, occupancy rates and rental rates are on the rise in many markets across the country. “The overriding factor is a sentiment among institutional fixed-income buyers that the real estate market has stabilized and is improving,” adds Orso. In 2012, CCRE Real Estate, through Cantor Fitzgerald, sold to over 150 bond investors and Orso expects that volume to grow in 2013.
That’s not to say there still aren’t challenges, including the amount of delinquent and defaulted CMBS loans still on the books and the uncertainty as to whether regulation may be enacted that limits the sector.
“Over a two-year period we have had a lot of volatility,” says Gerard Sansosti, an executive managing director at HFF in Pittsburgh. “People have to sit there and ask, ‘Is this business really back to stay?’ and ‘Do we want to take the risk of staffing up when we are not completely sure of where the business is going?’”
Closing the pricing gap
One of the things that has opened up the market is that CMBS lenders can once again go head-to-head more effectively on rate with insurance companies, banks and agency lenders, including Fannie Mae and Freddie Mac. CMBS rates have contracted nearly 100 basis points in the past year. During the week of December 19, the fixed-rate spread on a 10-year AAA bond was swaps plus 85 basis points compared to a rate of swaps plus 162 in the week of December 16, 2011, according to data from Commercial Mortgage Alert.
One of the competitive advantages for CMBS lenders is that the loans they offer traditionally feature higher leverage levels than bank or insurance company financing. While CMBS lenders are often willing to offer loan-to-value (LTV) ratios north of 70 percent, life insurance companies and banks tend to be more conservative. In the boom years, rates were the same for all lenders, making conduit loans irresistible because of the higher LTV ratios. But in the wake of the crisis, rates on CMBS loans spiked compared with other lenders, making the financing much less attractive for borrowers. Now that rates have come back into line, borrowers have a compelling reason to consider CMBS financing.
For example, a joint venture between BIG Shopping Centers USA and M&J Wilkow Ltd. secured a CMBS loan for its acquisition of The Waterfront in suburban Pittsburgh last fall. The group purchased a 764,691-sq.-ft. piece of the 1.4-million-sq.-ft. shopping center. BIG and M&J Wilkow were able to obtain a rate of 4.35 percent on a 10-year securitized loan for $81.36 million. Even more notable is that the borrowers were able to achieve 70 percent leverage on the property, despite the fact that the occupancy rate at the time of purchase was 89 percent with one vacant anchor and several leases that were expiring over the next five years.
“It fit perfectly into a CMBS execution,” Sansoti says. HFF closed the sale and arranged the acquisition financing, which was provided by Ladder Capital. Ladder was able to structure the deal around the lease rollovers and the vacant anchor and still deliver high leverage and a competitive price, notes Sansosti.
Providing a boost
The megadeals that the CMBS sector is known for returned to the market in 2012. For example, Vornado Realty and Donald Trump secured a $940 million CMBS loan on the 1290 Avenue of the Americas office building in Midtown Manhattan. Commercial Mortgage Alert reported last fall that Deutsche Bank, Goldman Sachs, UBS and Bank of China pooled their capital to make the conduit loan possible.
Such giant deals are expected to continue to boost issuance volume in the coming year. One deal that is currently being shopped is a major refinancing for Extended Stay Hotels. The privately owned hotel company, which has carried CMBS debt in the past, is working on a major refinancing of its entire portfolio. If completed, that single deal could generate CMBS financing estimated between $2 billion and $2.6 billion. “That is the kind of deal that will help to drive some fairly significant volumes in 2013,” notes Stacey Berger, executive vice president at Pittsburgh-based PNC Real Estate/Midland Loan Services.
“The splashier deals have been the supersize deals, but CMBS is building its base with smaller and midsize deals,” adds Weidell. For example, NorthMarq arranged $962 million in CMBS financing in 2012 on 84 loans, putting the average loan size at $11.5 million.
In fact, NorthMarq helped to secure two CMBS loans in the Dallas area in November on two unanchored strip centers that were both worth less than $5 million. Citi Group provided a 10-year term securitized loan with a 30-year amortization.
Both loans achieved a 70 percent LTV rate with a rate spread of 310 basis points on the first and 285 basis points on the second. Although the rate spreads were 25 to 50 basis points higher than what life companies could have delivered, the CMBS loan offered the added benefit of a lower non-recourse leverage point.
The CMBS recovery has come with some marked changes in the industry players, underwriting standards and how deals today are structured.
“You hear people talk about CMBS 2.0 or 3.0 and, frankly, it is more like 1.2,” says Berger. “The transactions are very similar to the deals that were originated and issued starting in the mid-90s, and certainly very consistent with what was originated and issued at the peak of the market in 2006 and 2007.”
That is cause for some concern given the high default rates on loans issued those years that are still working their way through the system. As of December, the CMBS delinquency rate stood at 9.71 percent, according to Trepp LLC, a New York–based investment research company.
That being said, there have been some changes in the structure that better align the interests of the senior investors and the most subordinate investors. The most notable shift has been structuring deals to identify more clearly the protocol on who controls the loan.
Essentially, the B-pieces are significantly “thicker” than they were in the past, notes Berger. “So they are a lot less likely to change control as losses aggregate,” he says. Change of control provisions also are now triggered by appraisal reductions in addition to realized losses. Once a change of control does take place, the succeeding control actually passes to an independent third party, senior trust advisors or operating advisors that have been established on behalf of the investors by the trust.
From the borrower’s perspective, CMBS lenders, while more aggressive than some other financiers, are more conservative than they once were. CMBS loans, much like other financing vehicles, are facing tougher underwriting standards. Lenders are paying more attention to property cash flow and funded reserves. The more conservative CMBS market is not necessarily a bad thing. “It is a fairly good environment to operate in, because you don’t have crazy aggressive players disrupting the market,” says Weidell.
Adding to the uncertainty are pending reforms related to great risk retention as part of the Dodd-Frank Act and new capital standards as part of Basel III. Among the issues still on the table is a reform that would mandate a 5 percent retention of risk for conduit lenders.
Most lenders say they are not worried about changes that may be made due to Dodd-Frank, notes Sansosti. “For those CMBS lenders that have large balance sheets, it won’t have as much impact,” he says. “They already do balance sheet business and they are capable of holding loans on their balance sheet.” That being said, those lenders that have less capitalization and fewer resources could struggle if the current provisions are eventually passed.
Although the number of CMBS lenders is about half the total that existed at the peak of the market in 2006 and 2007, borrowers still have ample choices with about two dozen CMBS lenders active in the market today. Notable players such as Lehman and Bear Stearns no longer exist, Credit Suisse has opted to remain on the sidelines and many of the veterans in the market such as JP Morgan have returned, along with new entrants such as CCRE, Ladder and Jefferies.
CCRE entered the CMBS origination business in the wake of the financial crisis. Although Cantor Fitzgerald had been actively trading secondary CMBS bonds since 2008, the company launched its fully integrated commercial real estate finance company in 2010. CCRE began originating CMBS loans in November 2010.
“Given the dislocation at the larger banks and the anticipated capital requirement changes as a result of legislation such as Basel III and Dodd-Frank, Cantor Fitzgerald determined that entering the CMBS business would be a way to participate in the industry, use its dominant fixed-income sales and trading business and raise third-party capital,” says CCRE’s Orso.
CCRE is making loans across all property types, and the lender has made a point to differentiate itself by pursuing apartment deals. Although agencies represent about 75 to 80 percent of the multifamily lending market nationally, the remaining 20 to 25 percent is still a significant piece of business, notes Orso. “There are a lot of loans that agencies don’t do, and there are also those borrowers that, for whatever reason, don’t do agency lending,” he adds.
In early January, CCRE closed on a deal to provide $52.5 million to help recapitalize a 146-unit luxury apartment building in Philadelphia.
Road to recovery
Like all financing, CMBS is highly dependent on investment sales activity, which is gaining traction. Although sales are not near the levels that occurred during the frothy peak of the market, transaction volumes have rebounded to 2004 levels. Sales activity through November exceeded $225.7 billion, which puts the market on pace to edge ahead of the $229.0 billion that was achieved in 2011.
Another factor that could boost the CMBS industry in the coming year is a growing pipeline of maturities. Both 2013 and 2014 are expected to yield a modest level of refinancing opportunities with $53 billion and $55 billion in loans maturing, respectively, according to Trepp. However, there is a bigger wave of maturities in the wings that will hit in 2015, 2016 and 2017 as CMBS loans with 10-year terms expire. CMBS loan maturities are expected to total a combined $363.4 billion during that three-year period.
Despite a more promising outlook, lenders remain wary of the risks that remain in the market. There is concern that the shakeout from Washington, D.C., and its impact on the economy could impede deal flow, particularly as Congress battles over tax increases and spending cuts. Other macroeconomic factors such as a flare-up in the Eurozone crisis also could spill over to impact liquidity in U.S. capital markets.
It is those risks and lingering concerns that are hindering a more rapid CMBS recovery. Once some of the uncertainty is removed, it may eliminate some of the impediments to more rapid growth in the CMBS market. “I think some of these shops will see that there is reason to staff up and grow in the market,” adds Weidell.