Tuesday, March 25, 2014

The changing face of commercial property lenders

US commercial real estate prices have firmed up recently although the recovery remains uneven across the various sectors.

Source: Real Capital Analytics

Improvements in pricing are giving rise to higher deal volumes as investors chase yield-generating assets. Anecdotal evidence suggests that commercial property transaction volume remains robust for the current quarter. Commercial real estate investing is popular once again.

Source: Real Capital Analytics (note: the big pop in Q4 of 2012 was tax-related)

On the other hand, the amount of commercial real estate mortgage backed securities (CMBS) outstanding is still declining after peaking in 2008. Total balances are now at the lowest levels in seven years.

Source: SIFMA

Something is off. We know that property purchases are almost always leveraged (very few buy commercial properties with cash - the rental yield is just too low). So who is providing the mortgage financing? In the past many of the large banks would arrange these loans, pool them across multiple properties, and then sell them as CMBS. The securities would be sold in tranches, with cash from mortgage payments following a predetermined "waterfall" (senior tranche would get paid first and so on). It seems that in recent years the use of CMBS as a financing tool has become far less prevalent even as commercial property deal volumes pick up.
Bloomberg: - ... sales of commercial-mortgage backed bonds are falling short of predictions for the best year since 2007: Issuance slumped to $14.6 billion from $20 billion in the same period last year, according to data compiled by Bloomberg. Bank of America Corp. cut its forecast last week for deals tied to single loans, typically backed by the higher-quality properties that insurers target, as sales plunged 66 percent from last year’s record $9.1 billion.
Part of the trend has to do with securitization being out of favor in general. Banks for example can't hold material amounts of CMBS on their books for regulatory reasons but can on the other hand hold a portfolio of real estate loans. It's the same type of risk but the "optics" are different.

Another reason is competition for direct loan assets. Many institutional investors have been getting into direct investing and direct lending. Insurance firms for example often act like bankers these days: competing for rates, arranging loans, charging fees, etc. Except they are funding assets with premiums from insurance sales rather than with deposits. And many of these institutions are so hungry for yield that they undercut banks on pricing. Great for property buyers, bad for the CMBS market.
Bloomberg: - Insurers are offering 10-year loans with interest rates as low as about 4 percent, compared with 4.9 percent on new debt that will be packaged into bonds, according to Alan Todd, a debt analyst at Bank of America. Insurers are increasing those investments because they performed well for them during the credit crisis and its aftermath, Woodwell said.
MetLife, the largest U.S. life insurer, has increasingly turned to real estate to bolster profits and support long-term obligations as the Federal Reserve holds interest rates close to zero for more than five years. Last year, MetLife boosted lending for commercial properties 19 percent to a record $11.5 billion, funding loans including $450 million to Shops at Columbus Circle in the Time Warner Center in Manhattan and $500 million against its own New York headquarters at 1095 Avenue of the America.
Even some pensions are moving into direct lending as this "shadow banking" market picks up steam. So if you are looking for a mortgage to fund your commercial property purchase, these days your banker won't necessarily be a bank.

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