Colorado Real Estate Journal - February 18, 2015
The numbers are in and commercial mortgage-backed securities lending is back. According to Trepp, the industry’s largest database of securitized mortgages, U.S. conduits originated $94 billion in CMBS debt in 2014, a 9.2 percent increase from the $86.1 billion originated in 2013. It was the fourth-highest annual total in history behind the years from 2005 to 2007, when lenders originated $167 billion, $198 billion and $229 billion, respectively. And even more interestingly, 2014’s CMBS volume is greater than the combined $93 billion of CMBS debt that was originated between 2010 and 2012. According to a recent survey conducted by the CRE Finance Council, CMBS origination is only expected to get bigger. On average, survey respondents are forecasting $125 billion of new CMBS issuance in 2015, and some even think that the number could be as high as $140 billion. The numbers are in, but what are they telling us? Why are CMBS loan originations roaring back, what could be consequences caused by increased CMBS activity and how does this affect you as a borrower? What caused CMBS issuances to increase so quickly in 2014? The answer is simple – improving real estate markets (including Denver), combined with investors’ search for yield, have increased investor demand for CMBS debt. Today’s average CMBS loan carries an interest rate of 4.25 percent, which, to some investors, is considered to be more attractive and have a higher relative value than alternative, lower-yielding investments – mainly investment-grade corporate bonds and government treasuries. For example, on Jan. 23, the 10-year U.S. Treasury note reached a 20-month low of 1.8 percent, while the 30-year U.S. Treasury note reached an all-time record low of 2.38 percent. In search of higher, more attractive yields, more and more CMBS lenders are entering the market. We saw the number of CMBS lenders grow from 18 in 2011 to 35 in 2014, and more could potentially enter the market in 2015, due to pentup demand for higher-yielding investments. The CMBS market is a significant and important component of the overall commercial lending environment, and it is imperative that we have a strong CMBS market over the next three years, when more than $300 billion of CMBS debt matures nationwide. CMBS debt provides additional liquidity to the market, gives borrowers more choice and indirectly makes alternative lending sources (i.e., life insurance companies, banks) more competitive. In 2014, we originated more than $125 million in CMBS debt, and over the course of that 12-month period, we saw spreads compress, average loan-to-values increase and interest-only terms become more available (up to 10 years of interest only). It sounds like a broken record, but a significant amount of money is readily available at historically low interest rates, so it’s a very good time to be a borrower of commercial real estate debt. But as a result of more CMBS lenders in the market and increased competition, there is increased concern that underwriting standards are eroding. According to Moody’s Investors Service, one of the largest rating agencies used to establish bond ratings for the various bond classes at the securitization of a CMBS pool, the average CMBS loan at the end of 2014 had a Moody’s loan to value of 112 percent, a sizeable increase from an average MLTV of 100 percent one year prior. In order to calculate the MLTV, Moody’s normalizes rents, operating expenses and cap rates to address economic cycles and stress property values (Moody’s uses cap rates between 8 percent and 10 percent in Denver, depending on the property type). MLTVs typically range from 70 to 120 percent, and the prefinancial crisis high was an average of 118 percent back in the third quarter of 2007. Based on the increase in MLTV over the last four years, it’s only a matter of time before MLTVs exceed the prerecession high. The numbers are in but is the story clear? Is the abundant supply of capital and slowly diminishing underwriting standards sending a message that the market is overheating? Only time will tell if current property values and the underlying economy can support the large amount of CMBS debt aggressively flowing into the market. Regardless of how the story ends, today is a great day to be a borrower.