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CRE Finance World Summer 2015
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The Top Tier. The top tier markets/assets are in the 24/7 “inter­
national” gateway cities led by New York City (driven primarily by
the international buyer, the availability of trophy acquisitions and the
lack of new supply), San Francisco (driven more by technology and
its in-fill location), and South Florida driven primarily by the Latin
American buyer. Common themes are shared by these three markets:
1) attraction of foreign capital, 2) in-fill locations with barriers to entry,
and 3) limited supply of available assets. In an increasingly global
world, domestic buyers are competing vigorously for real assets with
foreign capital which often has exogenous reasons for investing in
the U.S., including capital safety and sovereign diversification.
The Bottom Tier. The bottom tier represents the assets with the
highest loss severities and the assets that were indiscriminately
lifted with the rising tide of valuations leading up to the financial
crisis. These assets represent the third mall in a one-mall town,
the last limited service hotel built on the edge of town, and many
assets trapped in those cities and suburbs experiencing negative
growth and/or bankruptcy, including cities such as Detroit. These
assets are experiencing the highest loss severities (often approaching
100%) and are the loans that have taken on permanent residence
in special servicing and will be the last assets of the trust to be
resolved. Often performing until they are not, these assets have
provided many unhappy endings for CMBS investors.
The Middle Tier. Assets in this tier have been overlooked and
are somewhat flying under the radar. They may represent assets
in markets such as Atlanta, Dallas and southern California.
To be clear, not all assets here will succeed but managers who
can identify the diamond in the rough in these markets will be
handsomely rewarded.
As the real property (and CMBS) markets continue to become
more clearly stratified and tiered by asset, CMBS investors will be
rewarded and/or punished for their ability to select the winners
and emerging winners from the middle tier as well as to avoid the
lower tier assets. “We are focusing on the middle-tier markets
and working hard to find the winners there,” commented George
Carleton from C-III. “This is the area in CMBS where we are finding
the most value added. It is overlooked at the moment and requires
substantial local knowledge.”
Where are the Opportunities?
With CMBS spreads and volumes having recovered significantly
since 2009, all of our participants lamented that it has become
increasingly difficult, though still possible, to generate outsized
returns in CMBS and commercial real estate debt. As spreads
have improved, the CMBS market has evolved from a “commodity”
market with many hot money managers replacing traditional investors,
to a specialist market requiring the combined skills of deep real
estate know how, coupled with bond structuring capabilities.
Among our participants, four general areas of opportunity
emerged, domestically.
Transition Lending. Transition lending, as well as construction
lending in top tier cities, is seen as an excellent current opportunity.
These kinds of loans do not fit in CMBS and are often challenging
for a traditional bank or life insurance company to provide efficiently
or in a timely fashion. While transition lending has long been a
staple of opportunistic lenders, construction lending represents
a new frontier for non-traditional lenders.
Risk Retention Arbitrage. Our panelists saw an opportunity to
acquire subordinate CMBS and “B-Pieces” ahead of the adoption
of Risk Retention in 2016 as these investments will carry greater
liquidity and tradability and will therefore contain substantial
trading upside. It was also felt that the credit quality of these
investments for the recent vintages was much stronger than their
cohorts in CMBS 1.0.
Manufacturing Mezzanine. As Mezzanine loans have come back
into vogue and pricing has continued to tighten, an opportunity
has been identified to originate the whole loan, sell the senior
and retain the resulting highly-customized Mezzanine loan with
premium pricing. It was observed that the senior portions of such
loans could be sold directly (to either a portfolio lender or into a
CMBS securitization), or indirectly via a CLO or CDO financing
which has made a comeback in 2014/2015.
CMBS “Legacy” Markets. Finally, all agreed that multiple opportunities
remain in the CMBS “Legacy” market for those investors with the
expertise to sift through the collateral and identify undervalued
assets. Structured Investment Vehicles (SIVs) seized during the
financial crisis, as well as “hot money” investors, are providing a
steady stream of legacy CMBS opportunities to the secondary
market. Additionally, as banks and dealers are facing increasing
capital pressure, their CMBS inventories must be kept lean, creating
opportunities for longer-term investors.
While the market opportunities are changing daily against an
increasingly volatile and globally interconnected investment
universe, CMBS, and related real estate debt (such as transition
loans), continues to present attractive investments for seasoned
investors with the requisite expertise and discipline. “We are
fortunate to be in a strong capital position and to have a steady
track-record of lending in the U.S. which affords us the opportunity
to expand our lending envelope to more transition oriented lending
CMBS 2.0 — State of the Market 2015