Commercial mortgage performance improves

Commercial mortgage loan activity set a torrid pace over the last 30 days according to the Barron's/John B. Levy & Co. National Mortgage Survey. The survey found monstrous levels of activity in both the securitized and the whole loan side in strong contrast to past years when the "summer doldrums" seemed to set the pace for market activity. Loan volume was at levels not seen since 1986.

On the securitized side, a number of conduits marketed pools of loans which they had previously made and found the public market reception to be quite strong.

On the whole loan side, the market has quickly turned into a case of "lender gridlock" as institutions sought to process and underwrite a seemingly endless number of commercial mortgage loan origination requests.

Institutions all profess to want to think "outside the box" and find market niches where they can obtain above-average spreads without extraordinary risk. The hot property types today are -- believe it or not -- office buildings and hotels! These are, of course, the exact two property types which caused catastrophic damage to the industry just a few short years ago. But that damage left a shortage of capital and as a result a few forward-thinking institutions have been able to step in and make first mortgages on these property types which seem to be extraordinarily well secured even to those with more than a trace of akepticism in their bones. A large number of survey members this month were gushing over the attractive transactions which they were finding. Because office buildings make up some 35% to 40% of the commercial real estate stock, it is, in fact, hard to ignore the sector for any prolonged period of time.

Commercial mortgage performance numbers seem to support the decision to re-enter the office market. For the 12 months ending June 30, 1995, office buildings showed a total return of 12.93% according to the preliminary results of the Giliberto/Levy Co. Mortgage Commercial Performance Index. This was clearly the strongest performance by any property type even though credit losses were still high due to losses on previous loans. Interestingly, the weakest performance came from the darlings of the institutional market -- the apartment sector -- which turned in a total return of only 10.78%. These returns should be compared to the Lehman Brothers BAA bond index which showed a duration adjusted return of 12.60% for the same period. For the second quarter alone, the aggregate commercial mortgage index showed a total return of 6.11% vs. the Lehman adjusted index of 5.98%.

Because lenders were inundated with new loan submissions, they took the opportunity to both widen their spreads modestly and do some tightening of underwriting standards which had honestly begun to wobble. More than a handful of lenders have already met their 1995 allocation and are therefore out of the market at least on a "de facto" basis. To be sure, they are loath to admit it as they don't want to miss an opportunity to look at transactions which might fit their need. Rather than indicate they are "out," most merely stressed that they have become more "selective" or "picky." In spite of the general spread widening, lenders seemed as aggressive as ever for mortgages with a term of five yars or less.

Although it doesn't sound terribly exciting, affordable housing has institutions all cranked up to invest on both the equity and debt sides. Affordable housing is generally defined as apartments which can be rented by people who have median incomes below 60% of the area's median income. On the equity side, these transactions generate incredible tax benefits including tax credits which give buyers a 15% return on their investment. On the debt side, lenders seem eager to make long-term loans on these projects because the debt is less than 50% of the cost of the units. Also, the chances of foreclosure are slight since the institutional owners of the tax credits can't afford to allow a foreclosure during the first 15 years of the project's existence.

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