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CMBS Market Shows Increasing Vitality

The commercial mortgage-backed securities (CMBS) market appears to be on the mend, with a spike in issuance compared to the same period a year ago and a glimmer of the first conduit deal since 2007. With investors feeling more confidence about the state of the U.S. economy in general and commercial real estate prices in particular, issuance this year could reach $30 billion, some market observers say.

Year-to-date, the U.S. market saw $2.3 billion in CMBS issuance, compared to no issuance in the first three months of 2009, according to Commercial Mortgage Alert, an industry newsletter. At least some of the notes covered loans on retail properties. For example, in March, Ramco-Gershenson Properties Trust, a Farmington Hills, Mich.-based REIT, closed on a $31.3 million CMBS loan with J.P. Morgan secured by two centers in the Midwest. In addition, Glimcher Realty Trust recently closed on a 10-year, $46.0 million mortgage loan that is structured to be sold into the CMBS market secured by Polaris Towne Center in Columbus, Ohio.

The recent deals illustrate that while retail still ranks behind multi-family and office properties, conduit lenders are open to issuing loans on some retail properties, particularly well-performing grocery-anchored centers, says Dan Gorczycki, managing director in the New York office of Savills LLC, a real estate services provider. “It’s still one of the three main food groups,” he notes.

But lenders are staying away from unanchored strip centers and most malls, even well-performing ones. That’s because they prefer to keep the loan amount in the $20 to $30 million range. A class-A mall would normally require a deal size of at least $100 million, making the issue more difficult to sell in a still nascent bond market, according to Groczycki.

With smaller deals on well-run assets, banks can always keep the loans on their books if they can’t sell notes into the secondary market. “They are not doing this purely for profit, but to jumpstart the market, which helps start the rest of their books,” he says.

Financial institutions ranging from Wells Fargo to Bank of America to Deutsche Bank are working on more CMBS loans, says Gary E. Mozer, principal and managing director with George Smith Partners, a Los Angeles-based real estate investment banking firm. He notes that conduit shops have begun increasing their staff in anticipation of future deals. “There is huge demand for the bonds,” he says.

The biggest news in the CMBS universe right now may be a reported conduit loan put together by the Royal Bank of Scotland (RBS), which is scheduled to close later this month. The few deals that have taken place in the CMBS market since last fall have tended to feature a single borrower, as banks tried to insure investors were not spooked by loan structures that were too complex. The RBS transaction reportedly involves up to five borrowers, with a mix of office and retail properties. The notes from the approximately $300 million deal appear to be getting a positive reception, according to Tom Fink, senior vice president with Trepp LLC, a New York City-based provider of CMBS and commercial mortgage information.

“I think everybody was glad to see the first [multi-borrower] deal get off the ground,” Fink notes. “There always has to be the first deal and while it’s not a lot of borrowers, it still represents multiple borrowers and multiple properties and multiple property types, so it’s a step in the right direction.”

Back in the heyday of the CMBS market, a standard conduit deal could include anywhere from 150 to 300 borrowers, according to Fink.

The fact that RBS was able to get the conduit loan off the ground so early in the year is also a positive sign and may have to do with investors’ increasing confidence in the future of the market. With fourth quarter 2009 GDP growth reported at 5.6 percent and 162,000 jobs added in March, “investors will become increasingly comfortable buying bonds at tighter spreads, reinforcing the rally,” wrote J.P. Morgan analyst Alan L. Todd in a March 26 note. Based on Moody’s/REAL Commercial Property Price Index, J.P. Morgan researchers also believe that commercial real estate prices may have bottomed.

For the week ending March 31, Commercial Mortgage Alert reported that spreads on AAA-rated, fixed-rate 10-year conduit loans stood at 403 basis points, compared to a 52-week average of 568 basis points.

Given positive investor outlook and rumors of more multi-borrower CMBS deals in the works, Fink notes total CMBS issuance this year could reach between $20 billion and $30 billion. Previously, researchers expected about $15 billion in issuance in 2010. That's a far cry from the industry's peak years. In 2007, for example, there was $233 billion in U.S. issuance. But it does represent a starting point in the recovery. One of the biggest unknowns in the market right now remains the long-term fallout from the end of the legacy CMBS program, which the Federal Reserve Bank of New York announced on March 31. So far, the program’s end has not had any visible impact on demand for CMBS notes.

“You can still get a premium spread relative to other asset classes, so the return is very compelling,” says Mozer. “If the spreads stay the same, I think there will be plenty of money for [CMBS] with or without government programs.”

—Elaine Misonzhnik

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