Investors, servicers, sponsors and other professionals involved in securitizing real estate debt are pinching themselves over the success their industry has enjoyed the past couple of years. Everybody knows the good times will not roll on forever. What’s keeping investors up at night is figuring out when the other shoe is going to drop. That was the buzz at this week’s Commercial Mortgage Securities Association CMBS Investors Conference held in Miami.
The volume of CMBS and CDO issuances has ballooned during the past two years. CMBS issuances hit $299.2 billion in 2006, a $60 billion gain over 2005 and more than double 2004's volume of $128 billion. Meanwhile, issuances commercial real estate CDOs (more on those below), grew to $34.3 billion in 2006--a 62 percent increase over 2005 and more than four times the volume of issuances in 2004. (Robert Ricci, managing director for Wachovia Securities projects 2007 volume to reach $60 billion). At the same time, delinquencies and defaults for loans in the pools are at record lows. And that's exactly what worried attendees.
With everything humming along, spreads between the tiered credit rankings have tightened. That poses a risk. The lack of any downturns in CMBS means that fewer people in the industry have experience working through a down cycle.
“We don’t have a lot of skilled people with experience to deal with workouts,” said Charles Spetka, president of CW Capital Asset Management. Today, younger executives are climbing up the ranks, but few have experienced the hardships of a true real estate downturn. When things do go bad, experts expect there will be a race to hire anyone with experience navigating choppy waters.
Of all the property types, CMBS investors are the most bearish on the retail sector.
In one session, all four panelists pointed to the office sector as the best bet for 2007; with multi-family and industrial garnering a few nods. Randy Mundt, president and chief investment officer for Principal Real Estate Investors, cited the lack of optimism for the retail sector, which prompted this exchange.
“We’re most cautious on retail today,” Mundt said. “We’re concerned by consumer-related issues and worried about retailer credit. It’s never been a strong credit industry any way. And now, there’s a lot of LBO activity which is worrisome.”
Steve Coyle, managing director and chief investment strategist for Citigroup Property Investors, was even more bearish.
“There will be fallback—in 6 months to a year—from consumers pinched by falling home prices,” Coyle said. “We worry about malls even more than shopping centers because of this, but we’re worried about both.”
Michael Gilberto, managing director for JP Morgan Asset Management, added that he wasn’t too optimistic about shopping centers either because of the amount of construction in that sector. “Those centers have built more space than any time since 1990,” he said.
Commercial real estate financiers are getting a lot of mileage out of their newest toy–commercial real estate collateralized debt obligations.
There are a lot of differences between CMBS and CDO–too many to try and encapsulate here. The key difference is that issuers have the option to actively manage the pool of assets inside CRE CDOs. They can cycle loans in and out, change property types, change geographic distribution (all within limits, of course). Also, issuers are not limited to fixed-rate mortgages. It can include that, but more commonly includes floating rate debt of all stripes. Managed pools can also include REIT and REOC debt, mezzanine financing, preferred equity and other derivatives. Another difference is, unlike with CMBS issuances, sponsors can (and often do) retain ownership of some of the pool.
From a sponsor standpoint, it seems to be an attractive option and CRE CDOs promise to play a growing role in providing financing for the commercial real estate sector. And, because the pools are actively managed, sponsors can charge higher fees–as high as 45 basis points compared with 20 basis points for CMBS.
-- David Bodamer