Panic Overstates Risk in Commercial Real Estate

Retail Traffic's sister publication NREI uses a recent Torto Wheaton report as a jumping off point in discussing why commercial real estate isn't in as bad shape as you might think reading some of the reports circulating these days.

The thing that seems to be sending people off the deep end are the CMBX indices, which are signaling defaults risks well in excess of levels CMBS bonds have historically experienced. The CMBX indices were created by Markit as a way to allow the creation of derivatives trades off CMBS activity. People really started paying attention to the CMBX indices (of which there are four) after Markit's ABX indices correctly signaled huge problems in sub-prime mortgages just before things went awry.

But the CMBX indices needs to be viewed with some grains of salt. The way the indices work is that there are new ones created every six months using the most recent 25 issuances. That's why there are four in all. That can mean that some CMBS issuances are left out of the CMBX entirely--if more than 25 come out in six months. It could also mean some are getting double counted--if less than 25 issuances occur. Moreover, trading volume on the indices is quite low, enabling bets one way or the other to have a disproportionate effect on the indices. There's widespread belief that some hedge funds are using the CMBX as a way to short CMBS bonds and therefore pushing the indices out of whack with reality. The Wall Street Journal covered some of this ground about a month ago.

Anyway, you can see what NREI has to say about the matter here.

Against a backdrop of strong fundamentals, the analysis reveals that the 10-year loss rate for the entire CMBS conduit market is just 2.53%. Worse case scenario — under pressure of a major financial stress — the highest 10-year loss rate still only comes in at 8.5%. That is not to say that all vintages of CMBS were created equally — 2006 and 2007 vintages are projected to see loss rates twice as high of those found in the 2002 and 2003 vintages, as well as later issues.

Currently, according to the report, CMBS and CMBX markets have priced in losses tied to doomsday estimates, more in line with 1992, at which point commercial banks lost 160 basis points.

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