JANUARY 20, 2011
Reported by Joseph Weishaar, ULI New York Young Leaders Group
Over 150 members of ULI gathered for a discussion about the current state of the CMBS market. According to the panel, there has been a huge turnaround in the real estate capital markets over the past year. Panelists expected $30 to $40 billion in CMBS issuances in 2011 compared to $10 billion in 2010. Relative to the RMBS market, which has suffered from put-backs and legal battles, the CMBS market has faired well.
One of the major themes for 2011 is that there will be greater capacity on the lending side than there will be on the product side as investors search for yield. The imbalance between supply and demand has caused CMBS yields to come down much faster than many market participants thought, although pricing is not yet competitive with other sources of capital for investment grade deals.
A major reason for this is that the market for B-pieces remains shallow since buyers are no longer able to finance their positions with CDOs. The current buyers of subordinate tranches are being careful and originators are seeing a lot of loans kicked out of the pools as result. Before the financial crisis, there was dedicated capital for B-pieces. Now the market is not nearly as committed and investors are only buying subordinate tranches if the price is cheap.
The major meaningful change for newer CMBS issuances is the ability for an “appraisal reduction” to change the controlling holder status of a CMBS issuance rather than actual losses. In the past, the owners of the riskiest slice of the tranche had discretion to extend a loan rather than foreclose, which created the potential for conflict between subordinate and senior tranches. On new CMBS issuances, an appraisal can cause control to move from the subordinate tranche to the next senior tranche when the subordinate tranche is appraised “out of the money.”
In terms of legacy CMBS, special servicers are starting to work out deals by bringing in rescue capital from investors. This has caused pricing to come back for legacy CMBS as investors begin to anticipate a lower level of loss severity.
According to Randy Reiff, Managing Director and Head of CMBS at Macquarie, the biggest fear is that the capital markets get out ahead of the fundamentals and that lending standards begin to weaken, which may eventually lead to another crisis.