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CMBS Market Strengthens in Second Half of 2017, Despite Market Fears

The fear that borrowers and lenders had at the beginning of 2017 has proven to be largely unwarranted.

Prior to December 24, 2016, when the Dodd-Frank Act’s risk retention rules went into effect, CMBS lenders and borrowers anticipated that these regulations might run small lenders out of the market, cause lenders to become overly conservative and make it increasingly difficult to find financing for commercial real estate transactions, especially in secondary and tertiary markets.

Despite these less-than-optimistic predictions for the market, CMBS loan volume has gradually increased and the market has remained steady throughout 2017 thus far. In fact, CMBS issuance reached $38.8 billion at the end of the second quarter, according to CBRE.

The biggest change in the CMBS market following the implementation of the new risk retention rules, which require originators to hold five percent of the loans they issue as opposed to selling them off as bonds, has been the move towards more conservative underwriting.

As these lenders are now pricing their deals with risk built-in, the cost of the capital has slightly increased, but not by upwards of 25 basis points, as was predicted. CMBS spreads today are 5 to 10 basis points higher.

Smaller lenders that initially feared that the changes caused by the risk retention rules would completely run them out of the market have seen their fears proven to be false. According to Trepp, 21 lenders have participated in the market at of the end of the second quarter. We continue to see smaller lenders operating in the CMBS market, despite the restrictions of the Dodd-Frank Act, and expect more small lenders to enter the market by the end of the year.

That said, borrowers and mortgage brokers have been slightly more inclined to work with larger institutions, such as Wells Fargo and Bank of America. These financial institutions deal in larger loan volumes, making them better-suited to address the risk retention rules and provide borrowers with certainty of execution.

Borrower interest for CMBS loans and the availability of capital is also continuing to increase, further signifying a strengthening CMBS market for the second half of the year. CMBS issuance is predicted to reach a total of $70-75 billion by the end of the year, which is in line with the volume of issuance in 2016 and steady considering historical values.

While there has been some pullback in certain secondary and tertiary markets believed to be higher-risk, the sufficient availability of capital coupled with competitive rates have made CMBS loans more attractive to borrowers in many cases.

The climbing number of originated loans at the beginning of 2017 points towards a trend that will likely continue throughout the rest of the year, even with the added pressure of risk retention rules. Borrowers are still relying heavily on CMBS loans to finance commercial assets.

Finally, there was also concern regarding the wall of CMBS maturities and how this would affect issuance in 2017. However, at the completion of the second quarter, it does not seem to have affected the market substantially.

Even with billions still set to mature by the year’s end, lenders want to increase originations. Moreover, many borrowers with loans that matured this year refinanced at much lower rates than the relatively high interest rates prior to the downturn in 2006 and 2007.

Ultimately, the fear that borrowers and lenders had at the beginning of 2017 has proven to be largely unwarranted. Although we have seen some slight changes from lenders in their underwriting and the way they are pricing deals, the CMBS market remains a viable capital source for many owners and investors. In the next half of the year, we anticipate a healthy CMBS landscape.

Mitch Paskover is the president of Continental Partners, a national mortgage banking firm that provides capital and financial services to real estate owners and developers nationwide.

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