securities. “You may have a long way to go, but it’s clearly re-
emerging,” Ashner says. “The real estate markets from all aspects
need it and can benefit from it. Real estate that can be refinanced
For the big wave of refinancing needed by REITs and other real
estate owners in the coming years, there is plenty of room for loans
with good coverage, low loan-to-value (LTV) ratios and solid
performance, adds Tiesi of RBS. “There is a lot of capacity in the
CMBS market right now to do loans that are reasonable.”
Roughly $325 billion in commerical real estate mortgages are
coming due in 2011, according to Green Street Advisors. While
many of the loans will be refinanced by existing lenders such as
banks and life insurance companies, CMBS will play a role, says
James Sullivan, a managing director at Green Street. “Some por-
tion of the $325 billion will have to come from some other source
and the CMBS market may be part of the solution.”
To be sure, investors have been willing to wade cautiously back
into CMBS, given the entirely new conditions for under writing.
Transactions now are getting done in part because they have
much lower leverage relative to the period before the credit crisis.
For example, the average LTV was 78 percent on the JPMorgan
transaction, according to Fitch Ratings, whereas the average for
deals done in 2007 and 2008 was 111 percent.
The loans going into securitization also have stricter conditions.
Nowadays, property cash flows that are underwritten by the banks
are often below what the actual 2009 cash flows were, says Huxley
Sommerville, group managing director at Fitch Ratings.
Also, a given market’s current vacancy level is used to help calculate the cash flows. No credit is being given for future increases
in rent or occupancy. Lenders are also using appropriate capital
expenditures. Amortization loans, rather than interest-only
loans, are being used in greater numbers than in the past.
“Today’s loans are more conservatively underwritten,” Sommerville says. “The interesting thing will be how long they maintain that
conservatism. At some stage in the future, competition will mean
the conservative aspects currently being displayed will decrease.”
Out of the Woods?
That lack of conservatism is what got the industry into trouble
in the first place.
Toward the middle part of the decade, lenders loosened underwriting standards, which were the most generous from 2006 to
2008. New delinquencies last June for fixed-rate conduit CMBS
loans were concentrated in the years 2005 to 2007, according to JPMorgan Securities research. Delinquencies for 2006 were $574 million, followed by $344 million for 2005 and $208 million for 2007.
Meanwhile, defaults on existing CMBS are still rising. About
3. 3 percent of all CMBS loans defaulted in 2009, compared with
0.6 percent in 2008, according to research by Fitch Ratings. Deteriorating real estate fundamentals such as rising vacancies and
falling rents have led to the escalation in defaults. Lack of new
CMBS issuance and the inability for real estate owners to roll
over debt have contributed to failing loans as well. All told, the
cumulative default rate will surpass 11 percent by the end of this
year, up from 6. 6 percent at the end of 2009, according to Fitch.
To no surprise, CMBS liquidations are also on the rise. In
June, 106 loans with an original balance of $676 million were
liquidated, compared with an average of 54 loans and $101
million on average per month in 2009, according to research by
More bad news will follow, observers say. Many lenders are
practicing so-called amend, pretend, and extend, working out
modifications instead of foreclosing, with the hopes that an economic recovery will boost sagging property values and cash flows.
At the same time, those same lenders will be loathe to refinance loans written in the boom years 2006 and 2007, when they
came with low capitalization rates and low coupons. Real estate
owners will find it difficult to refinance with much higher cap
rates and coupons in the coming years.
Low Volume Is New Order
While conservative underwriting has limited deal pace, so has
Insurance companies are stepping in to supply direct mortgages to real estate owners of trophy properties. So, while there is
plenty of capital coming into the markets, often it does not end
up in conduit loans. The competition has made it harder for investment banks to get deals done, as insurers can strike up direct
transactions with real estate holders.
“Insurance companies are bidding up pricing and making
some loans that may be otherwise uneconomical for conduit
lenders,” says Howard Chin, a managing director at Guardian
Life Insurance Co. of America, which holds a portfolio of about
$1 billion in CMBS. “We look at it as a means of diversification
and a way of getting some additional illiquidity premium for
lending to people we know or get comfortable with.”
That said, on the CMBS side itself, Guardian has shied away
from the more recent issues, instead sticking to the secondary
market. That means focusing on assets that were issued back in
2005 and earlier, as well as tranches such as AAA and others near