A Look Ahead at the Recovering CMBS Marketplace

CRE Finance World, Winter 2014

A Look Ahead at the Recovering CMBS Marketplace he commercial mortgage-backed securities (CMBS) marketplace, like most other financial and real estate markets, experienced dramatic changes over the past few years. The pre-recession CMBS cycle — CMBS 1.0 — grew to peak levels in 2006 and 2007, then combusted alongside virtually all other aspects of the financial markets worldwide. Today, the recovery in CMBS is palatable, albeit with volumes that are significantly lower than experienced at the peak. To varying degrees, CMBS players on both the origination and buy side are recovering from the recession and appear to be applying the lessons learned, resulting in improved quality of the CMBS product originated today. While improvements are reflected in sounder underwriting, and loans collateralized by superior real estate assets in general, this recovery is not without its difficulties. Looking forward, the challenges for CMBS 2.0 include competition from capital that has been on the sideline anxiously waiting to be deployed, a recovery that has been both tepid and uneven, and risk retention rules that have yet to be finalized. Further clouding the future, a $1 trillion wave of maturities is on the horizon including approximately $400 billion in peak era CMBS originations, which will mature between 2014 and 2017. Given both current production levels and estimated loan production growth, even quality assets will be difficult to refinance without equity gaps, and lower quality assets may not find traditional financing at all. As more lenders enter the space, increased competition to close loans may lead to lower quality underwriting and lack of consistency. The industry sits at an important junction, and time will tell if the participants repeat the mistakes of CMBS 1.0 or continue on the path of a new and improved CMBS 2.0. The Commercial Real Estate Lending Arena Today The CMBS marketplace is a rapidly expanding arena. Volumes have increased steadily year over year since 2009, when there was essentially no CMBS loan production. For 2013, Commercial Mortgage Alert projected origination volumes to reach between $60-65 billion. However, those forecasts have been revised CRE Finance World Winter 2014 78 upward throughout the year with expectations that 2013 issuance will now exceed $85 billion with Bank of America forecasting $100 billion for 2014. In addition to CMBS producers, insurance companies and commercial banks have also been ratcheting up their loan production. By most indications, the insurance companies are incrementally and judiciously expanding their business. The Mortgage Bankers Association reports a 19% increase in insurance company commercial real estate loan production comparing YTD 2013 through the third quarter 2012. Commercial banks, while displaying some hesitation in 2010 and 2011, are jumping back in more readily. Lending in general has picked up within this sector. The Mortgage Bankers Association reports commercial bank commercial real estate portfolio lending increased in production 22% YTD through third quarter 2013 over the same period in 2012. As the economy continues to improve, and the credit markets find their new normal, 2014 should bring new entrants to the lending markets and increased volume from both traditional and specialty finance lenders. As the number of participants and origination levels increase, so too will concerns surrounding underwriting standards and due diligence — two variables directly linked to the health of the entire commercial real estate lending market. Underwriting Standards Conventional wisdom dictates that quality loans are based on good real estate, reliable underwriting and sound structuring. The general industry consensus is that bull market underwriting was overly optimistic in its view of the markets, and coupled with lax underwriting standards, they contributed to significant losses. Although the recovery from these practices continues today, best practices in underwriting remains the dominant concern for market participants. As competition for quality loans intensifies, the risk of “loosened” underwriting standards also increases. This industry dynamic is a troublesome pitfall. Pro forma underwriting, as opposed to historical or in-place underwriting, and extending interest-only structures T Ned Smith Relationship Manager Sabal Financial Group Midge Brogan Managing Director Sabal Financial Group


CRE Finance World, Winter 2014
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