A publication of Winter issue 2015 sponsored by CRE Finance World Winter 2015 35 Exhibit 14 Historical Total Return (incl. dividends) Source: Factset; KBW Research. Commercial Mortgage REITs are Correlated with Treasuries and High Yield Bonds We believe it is worth comparing commercial mortgage REIT dividend yields with treasuries and the high yield bond index. Exhibit 15 below shows a historical spread over the three-year treasury of 7.5%, in line with the current spread of 7.8%, and the historical spread over the high yield bond index (HYB) of roughly 0.0% in line with the current spread of 0.7%. As a result, we believe the stocks trade as yield instruments, which is why we prefer that measure to price-to-book value. Exhibit 15 CMBS REITs vs. Fixed Income Historical Spreads Source: Factset; KBW Research. Historical Leverage Exhibit 16 below summarizes historical leverage ratios for the commercial mortgage REITs. We estimate average historical leverage (debt/equity) of 2.5x and a peak of 7.4x as compared to current leverage ratio of 2.0x. While underwriting standards in the prior cycle deteriorated leading up to the financial crisis, we believe the primary reason that legacy commercial mortgage REITs went out of business was due to excessive financial leverage and mismatched terms between assets and liabilities. In the case of credit facilities/repo, the terms were shorter than assets that extended due to borrower inability to repay or refi the loan. In the case of securitized debt, the commercial mortgage REITs held the first loss position, which resulted in greater losses than the overall market. Another nuance is that companies leveraged mezzanine loans and subordinated debt in the prior cycle, which we believe does not yet meaningfully exist today. Exhibit 16 Historical Leverage Source: Factset; Company reports; KBW Research. Modeling CRE Losses for Commercial Mortgage REITs “Although we are optimistic about the outlook for real estate fundamentals and mortgage REITs have had solid performance metrics in recent years, the increasingly competitive lending environment could create risk of increased losses in future years.”
CREFW-Winter Edition
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