Some investors in commercial mortgage-backed securities (CMBS) blame problems in the sector on hedge funds that short the CMBX — an index series that allows investors to take a position on CMBS. They argue that fundamentals in the underlying real estate remain fairly strong. Hedge fund activity has caused CMBS spreads to widen, creating pricing problems for CMBS. As of Oct. 24, spreads on the AAA-tranche in the CMBX S5, the fifth in a series of packaged CMBS deals, were more than 200 basis points.
John Jacquemin, president and founder of the Mooring Intrepid Opportunity Fund, a hedge fund that has a 25% exposure to commercial real estate, says his bets on the CMBX were placed in anticipation of an economic downturn and a correction in the credit markets.
The fund, which launched in March 2007, requires a minimum investment of $100,000 and posted a 37% return year-to-date through August 2008. Jacquemin is no stranger to making hay when dark clouds are hovering. In the early 1990s, he bid on distressed commercial debt packaged and sold by the Resolution Trust Corp., and then waited for the market to recover. Recently, NREI spoke to Jacquemin about the ongoing market correction.
NREI: Why did you expect commercial real estate to deteriorate?
Jacquemin: The road map we laid out in early 2006 was that there would be a correction in the housing market, and it would affect the consumer quite severely. The consumer had been spending very liberally when housing went up 10% to 20% in value. When prices correct, the opposite happens. Since consumer spending drives 70% of the gross domestic product, we felt that the economy would slow down, corporate profits would drop, unemployment would go up, and this would eventually affect commercial real estate.
The other factor is how real estate is valued. The market was so hot that buyers and sellers were agreeing to very low cap rates. They could borrow at very low rates. They made assumptions that rents would continue to grow.
NREI: How have your expectations of the repricing of credit risk played out?
Jacquemin: They have played out as expected, but the whole process has played out in kind of slow motion. We would have expected to be where we are today about a year ago. It has taken a lot longer, and I think it will continue. We are going to have a weak economy for another two years.
NREI: What will be the impact of the recent government actions to shore up the U.S. economy, such as the $750 billion bailout package?
Jacquemin: I think it will stop the credit markets from freezing up. Many of the steps the Fed has taken will prevent a meltdown of our credit markets, but I don't think it solves the insolvency problem. We have hundreds of banks that are hanging on by a thread that are really technically insolvent already because they have so many bad loans on their books, and the write-offs exceed their capital.
NREI: Do you anticipate further declines in commercial real estate?
Jacquemin: I do. The economy is continuing to slow, and we are seeing retailers pull back and corporations pull back on their office space. I know in Northern Virginia and Washington, D.C. there was more [office] space being delivered both last year and this year than there was space being absorbed. It is going to get worse before it gets better.