CMBS Issuance Hovers in the Stratosphere

Just when you thought the commercial real estate market should be taking a well-deserved summer breather, volume has exploded again. Total offerings of $17 billion to $20 billion were expected to come to market in the commercial mortgage-backed securities (CMBS) arena during the normally sleepy month of August, according to the Barron's/John B. Levy & Co. National Mortgage Survey.

Included in the queue was the third largest CMBS deal ever, a $3.7 billion offering from Wachovia Bank. Domestic CMBS volume is running almost 50% ahead of last year's record pace, and most observers wouldn't be surprised to see global CMBS issuance exceed $200 billion by year's end.

In early August, the U.S. Treasury announced that it would once again start reissuing 30-year Treasury bonds, commonly known as the long bond. While this is expected to have virtually no impact on the securitized side of the market, a number of life insurers and pension funds have indicated that they will be more aggressive in soliciting long-term mortgages — those with terms of 20, 25 and even 30 years.

They argue that they have numerous long-term liabilities, such as contracts to pay off lottery winners, and that the new 30-year bond will give them a more accurate pricing benchmark, and thus a greater interest in these longer-term financings.

Underwriting under scrutiny

Depending on whom you ask, real estate underwriting is: (a) improving, (b) steadily deteriorating, or (c) about the same. To be sure, any real estate pro can pick examples of all three. But it does appear that underwriting has turned a corner. Bankers are clearly offering fewer interest-only loans as that seems to be an especially sensitive subject.

In a slick attempt to avoid this sensitivity, a small number of originators are offering loans with a 40-year amortization schedule, dramatically longer than the traditional 30-year schedule. While these loans aren't technically interest-only, there is so little amortization occurring that they might as well be.

Once upon a time, underwriting was based on a thorough study of a property's previous history with some thought given to how the net operating income — essentially profits — might increase in the future. But that's not necessarily the case these days as bankers are stretching to make loans even when there is no historical data.

For example, the Communities at Southwood, a 1,286-unit apartment complex that is located in Richmond, Va., is currently being offered in a securitization sponsored by Deutsche Bank.

The property was purchased a year ago for $27 million, and sold in July for some $62 million following an $11.75 million renovation.

Delinquency rate waning

Meanwhile, Standard & Poor's recently released its second-quarter CMBS delinquency report. For the most part, the news is positive as domestic CMBS delinquencies dropped below 1%, the lowest level in almost five years.

Additionally, foreclosure losses were down materially. In 2003, liquidation losses were 41% of principal, declining sharply in 2004 to 29%. Year-to-date, that number is just a tad over 25%, clearly reflecting the vibrant sale market for real estate of all types.

While delinquency rates on most property types have trended down, those on multifamily properties have been remarkably sticky. As of the end of the second quarter, 1.75% of multifamily loans were delinquent compared with a scant .42% of retail loans, or a modestly higher delinquency rate of .65% for office loans.

If the condo market bubble bursts, that number will go dramatically higher as many condo owners choose to offer their condos for rent as the only financially viable alternative.

John B. Levy is president of John B. Levy & Co. Inc. in Richmond, Va. © Dow Jones & Co. Inc., 2004.


Selected CMBS Spreads*
To 10-year U.S. Treasuries
Rating 8/8/05 7/4/05
AAA 69-70 67-68
AA 87-88 86-87
A 97-98 96-99
BBB 154-159 156-161
BB 290-300 285-300

Whole Loans*
Prime Mtge. Range Prime Mtge. Prime Mtge. Range
Term of loan 8/8/05 Rate 7/4/05
5 years 5.24-5.34% 5.29% 4.83-4.93%
7 years 5.30-5.40% 5.35% 4.93-5.03%
10 years 5.40-5.50% 5.45% 5.12-5.22%
For loans of $5 million and up on amortization schedules of 25-30 years that can be funded in 60-120 days with 0-1 point.

*In basis points, or hundredths of a percentage point.

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