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What does '96 hold for commercial mortgages?

Commercial mortgage interest rates fell 3/8% over the last 30 days, according to the Barron's/John B. Levy & Co. National Mortgage Survey of major institutional lenders. Commercial mortgage spreads -- the difference between mortgages and Treasuries of the same maturity -- were virtually unchanged, so the lower rates stem wholly from declining Treasury yields.

The commercial mortgage arena, which ran on overdrive for most of the summer and early fall, has slowed down just a tad. Survey members are still finding plenty of interested borrowers, but the lines aren't nearly as long as they were just 30 to 45 days ago. A number of institutional lenders, who have already filled their 1995 quota, are now back in the hunt and are looking for closings in the first quarter of 1996. Most major commercial mortgage lenders have far exceeded their 1995 origination targets but are skeptical that they will be as lucky in the coming new year.

The yellow caution flag is flying at many institutional lenders as they are down right nervous about the retail market. In just the last three years, retail square footage on a per capita basis has increased almost 17%! Much of this has come in the form of "power centers" or "big box" retail. These centers are usually dominated by the "category killers" including Wal-Mart and Circuit City to name just a few. But while these two companies are doing quite well, the market is littered with the remains of retailers who once appeared to be invincible. Power center leases frequently contain clauses which increase a lender's risk. For example, when one of the anchors "goes dark" or leaves, a number of other tenants may have the option to leave as well. This "domino effect" can have disastrous consequences for the center's owners and lenders. Other tenants may have the right to cancel their lease if their sales do not exceed a specified minimum level. But not all retail is tainted. Many forms including traditional strip centers and malls are still eagerly sought by the lending community. Nevertheless, given recent bankruptcies of Bradlee's, Caldor's and Jamesway, caution is clearly merited.

It should come as no surprise then that the retail mortgage component of the Giliberto-Levy Commercial Mortgage Performance Index[SM] hasn't been a stellar performer. On a preliminary basis, for the twelve months ending Sept. 30, re, tail showed a total return after credit losses of 12%, which was below the aggregate index of 12.76%.

Further, for the third quarter alone, retail's total return of 1.17% was substantially less than the aggregate index's performance of 1.83%. Interestingly, the strongest performance was again turned in by the office sector, which garnered a 14.02% return for the previous 12months, barely nudging out the Lehman Brothers Baa adjusted bond index for the same period. Since the vacancy rate for U.S. office buildings at mid-1995 was at its lowest level since 1984, office building mortgages should continue to turn in very strong results.

Wall Street is nervously watching CS/First Boston, where the real estate and mortgage group has recently been placed under leadership of Andy Stone. Stone, while at Daiwa Securities, almost single handily invented the commercial mortgage conduit business leaving many to wonder what he is planning for an encore.

A few survey members mentioned that they are carefully reviewing their exposure to the Atlanta market. Though Atlanta is currently in the midst of a boom inspired by the Olympic Games, real estate veterans remember this as a town that has seen its share of busts as well. Apartments are being built at almost an incredible rate with many of these being marketed to the relatively affluent. One survey member commented that he expects a shake out to occur beginning in the summer of 1997, just one year after the Olympics have ended.

Ideas and comments are welcomed by E-mail: [email protected].

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