A newly released report by CBRE Torto Wheaton Research states that future commercial mortgage defaults and losses could be overestimated threefold. The culprit? Not surprisingly, overreactions in the credit markets are to blame, according to the report.
“While prices have been slow to change in the commercial real estate equity market, the commercial real estate debt markets have been driven by increasing spreads, and decreased availability of mortgage capital,” states the report. In recent weeks, prices of the CMBX — a set of derivatives that provide insurance against default — and prices in the commercial mortgage-backed securities ( ) market are “out of line with what any likely future income stream of the underlying mortgages would suggest.”
Despite an expected incremental rise in vacancies across all major property types over the next few years, vacancies are still expected to remain lower than 2002/2003 peak levels, and the 2008/2009 period is projected to see rents to continue moving upward into positive territory.
Against a backdrop of strong fundamentals, the analysis reveals that the 10-year loss rate for the entire CMBS conduit market is just 2.53%. Worse case scenario — under pressure of a major financial stress — the highest 10-year loss rate still only comes in at 8.5%. That is not to say that all vintages of CMBS were created equally — 2006 and 2007 vintages are projected to see loss rates twice as high of those found in the 2002 and 2003 vintages, as well as later issues.
Currently, according to the report, CMBS and CMBX markets have priced in losses tied to doomsday estimates, more in line with 1992, at which point commercial banks lost 160 basis points.
One of the big differentiators between today’s ailing economy and that of 1992, is that there is currently an equilibrium with supply and demand in commercial real estate, which should weather the storm even as the economy is running out of steam.
And, one of the biggest feared financial stressors — the collapse of a major investment bank — might still not bump the economy too far off its tracks. As all eyes are trained on the JP Morgan buyout of Bear Stearns, which includes some $16 billion in CMBS, that is not likely to be the event that finally sets the price of CMBS. Dumping the bonds onto the market would likely make little sense given the Fed’s pledge to take in hand $30 billion of the ailing investment bank’s most illiquid assets, including both residential and mortgage-backed securities.