Off to a wobbly start in 2016, the lending landscape for commercial real estate is expected to bolster as the year progresses. Yet investors and lenders remain uncertain about the extent of improvement, as the industry faces looming loan maturities and regulatory measures.
The CMBS market has been on shaky ground recently, as concerns about the stock market, China and the global economy dampened lender and investor confidence. “In the first two and a half months of this year, CMBS was virtually broken,” says Michael Riccio, senior managing director in the capital markets group of real estate services firm CBRE.
In May, CMBS delinquencies rose for the first time in 10 months, to 2.92 percent, from 2.90 percent in April, according to Fitch Ratings. (The firm expects delinquencies to remain below 3.0 percent this year.)
According to a recently released report by New York City-based research firm Real Capital Analytics (RCA), “Into the second half of 2015, the price of commercial real estate debt increased in line with turmoil in the corporate bond markets. RCA calculates that the average interest rate on commercial property loans (office, industrial, retail and hotel) came in at 4.4 percent in June 2015. By January 2016, this figure had increased to 5.0 percent.”
Late March brought some stabilization, with spreads recovering, at least partially.
“Sixty to ninety days ago CMBS was all but dead, spreads widened out and borrowers were being re-traded on most deals,” says Gerard T. Sansosti, executive managing director at financial intermediary firm HFF. “AAA-rated CMBS bonds widened out to 173 basis points, with BBBs widening to over 850 basis points. This was the bottom of the market. Since that time (in the last 30-45 days), pricing has come in significantly. The latest securitization priced at 117 for AAAs and BBBs were in the 625-725-basis-point range.”
In the interim, alternative sources of funding have risen to the occasion to fill the demand gap—and they don’t plan on going away any time soon.
One example of this is EB-5 funding. "For new construction and/or rehab projects in the Midwest and other locations, many borrowers are utilizing alternative sources of debt and equity, such as historic tax credits, new market tax credits and EB-5 funding," says Jim Doyle, senior vice president at Bellweather Enterprise, a commercial and multifamily mortgage banking company. Bank and life insurance companies have also positioned themselves to gain market share should CMBS issuance not return in a significant way.
“During the market volatility [in the first quarter], a number of our borrowers avoided the CMBS market and went with debt funds or bank financing, even if it required some level of recourse. They were willing to put in more equity or take on recourse to avoid a CMBS execution,” Sansosti says.
For their part, banks are becoming increasingly more comfortable with longer loan terms, now going up to 10 years, and funding higher leverage deals if recourse is on the table. They are also increasingly funding new construction loans.
In its April 2016 Lender Forum report, CBRE notes that life insurance companies are competing with CMBS lenders by structuring loans at 75 percent loan to value ratios (LTV) for higher mortgage rates.
“Life companies want to be at 60-65 percent LTV or below and are pricing deals below 200 basis points,” says Sansosti. “CMBS lenders are really only competing with life companies on higher leverage transactions (65 percent-plus LTV) and larger single asset deals ($200 million-plus loan size). With the recent tightening in the market, we have begun to see CMBS lenders competing with life companies on some of the lower LTV opportunities (i.e. 50-60 percent LTV).”
“Life companies continue to be aggressive this year after a record year in 2015,” he adds.
Insurance lenders accounted for 13.0 percent of all lending across commercial property types in 2015, according to data from the Mortgage Bankers Association (MBA), an industry trade group. Banks held the most market share last year, accounting for 41 percent of all lending, while CMBS lenders accounted for 16 percent of the market, down from 27 percent in 2014.
That downward trend continues in 2016. Owners and developers who can avoid using the CMBS market right now are doing so, with Simon Property Group being a prime example. Should CMBS not perform up to par, the REITs are quite comfortable going to life insurance companies, according to Steven Marks, managing director for corporate finance and REITs with Fitch Ratings.
“REITs generally endeavor to have as many different sources of capital as possible, such as unsecured debt, bank capital, preferred stock, joint ventures, asset sales, and even through the secured market if they really need it,” Marks says. This year brought an increase in assets sales, for example, to raise equity across several REITs, he adds.
Looking ahead through 2017, industry insiders are generally optimistic, pointing to solid property fundamentals, a stable market and good discipline from lenders. “Lenders are comfortable, but thinking about where we are in the cycle,” Riccio says.
With the wave of loan maturities coming due this year, it will take about 18 months to clear loans made in 2006 and 2007, industry sources say. The market will also have to adjust to Basel III bank reserve requirements and the Dodd Frank risk retention framework that are scheduled to take effect later this year.
“When they figure out what they will do about risk retention, then CMBS spreads should stabilize, and that engine will pick up again,” Doyle says.