Hot Potato
Oct 1, 2008 12:00 PM, By Elaine Misonzhnik
CMBS comeback
The most favorable scenario for the commercial real estate industry would involve the speedy comeback of CMBS loans, which would fill the current debt gap. “CMBS is an efficient and terrific source of capital for real estate and, theoretically, it's unlimited capital,” says Rendak. But although most industry insiders say they are certain CMBS will eventually come back into the market, that's not likely to happen for at least 12 to 18 months, according to Chandan and others.
As it stands, the debt vehicle that served as the preferred source of real estate financing for the past five years and last year covered 70 percent of all transactions is no longer available. Meanwhile, the more traditional lenders, which include insurance companies, pension funds and national banks, haven't been stepping up their game. In the second quarter of 2008, commercial/multifamily mortgage originations by commercial banks fell 29 percent compared to the same period in 2007, to 289, according to the MBA. Originations by life insurance companies fell 27 percent, to 119. And the total number of originations for retail properties fell 63 percent, to 169. What's more, when they do lend, these conservative players demand much more restrictive loan terms than Wall Street lenders, including 60 percent to 65 percent loan-to-value ratios, a minimum of 1.3 in debt service coverage ratios, 25-year amortization terms, recourse and no interest-only deals, says Akeman.
In addition to the fact that CMBS investors have lost all confidence in the credit rating agencies — and rightfully so, since the agencies proved too eager in assigning triple-A ratings to bonds that eventually ended up in the junk basket — they worry about the state of the U.S. economy and its effect on demand for commercial real estate. Until they see a significant improvement in U.S. consumer confidence, they will stay away from buying paper backed by retail assets, says Adam B. Weissburg, partner with Cox Castle Nicholson LLP, a Los Angeles-based real estate law firm.
Even when CMBS debt comes back into the picture, it will feature more conservative underwriting, in line with traditional lenders' terms, and won't reach the levels achieved at the peak of 2007, which saw $237 billion in CMBS issuance. Going forward, experts say CMBS issuance will average approximately $50 billion a year. CMBS debt was designed to work for stable, income-producing assets with no need for major improvements, according to Weissburg. Add a level of risk to the equation and the system goes haywire.
“CMBS lenders will have to crawl before they walk, before the industry can prove to the investors the value of underlying properties,” says David B. St. Pierre, cofounder and president of Legacy Capital Partners, a Lyndhurst, Ohio-based private equity firm.
Holding out for a hero
With scant hope for a CMBS comeback, some industry insiders pray for the emergence of another major source of capital. In the first half of the year, regional banks picked up some of the slack from Wall Street and other real estate funders, but their lending capacity is limited. By mid-year, they accounted for just 5 percent of all acquisition financing in the commercial real estate market, down from 7 percent in 2007, according to New York City-based Real Capital Analytics. Meanwhile, national banks accounted for 8 percent of all financing, down from 26 percent last year, and finance/management firms for 5 percent, down from 9 percent in 2007.
Insurance firms increased their lending business slightly, to 7 percent from 6 percent, but that's still a fairly conservative figure. “Right now, there are only two or three types of lenders out there, and everything is very conservative,” says Mason.
One alternative Mason still has some hopes for are covered bonds — securities that function in a way similar to CMBS bonds, but remain on the issuer's balance sheet. They're more conservative structure guarantees that even if the issuer goes bankrupt, the way Lehman did, the bond investors still get their money back. The lower level of risk associated with covered bonds might lure those investors back into the market, which is why the Federal Reserve and four of the country's biggest banks, including JPMorgan, Wells Fargo, Bank of America and Citi, are already considering issuing such bonds in the residential market.
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