In what is surely a welcome sign for commercial real estate borrowers, the commercial mortgage-backed securities (CMBS) market finally started to demonstrate some positive signs of life in 2009’s fourth quarter, after almost 18 months of complete inactivity. Toward the end of the year, three separate issuers successfully brought deals to market and sold their mortgage bond issuance. This is a big step forward for commercial real estate investors as well as the financial community at large, and is hopefully the beginning of a return to lending-market normalcy.
As a quick review, CMBS are bonds backed by commercial mortgages. A basic CMBS transaction structure starts with lenders who pool the loans of multiple commercial properties, and then sell the income stream from the mortgage payments to investors in the form of bonds. When the bonds are sold to the investor community, capital is returned to the lender, who is able to redeploy that capital and make more loans. In this structure, capital flows efficiently between borrowers, lenders and investors; hence the name “conduit” is given to lenders using these financing approaches.
Historically, conduit lenders provided significant lending volume and liquidity to the commercial real estate community. According to the Mortgage Bankers Association’s Q3 2009 Quarterly Data Book, CMBS and other securitized products comprise nearly 21 percent of today’s roughly $3.43 trillion in outstanding commercial-property debt. Ignoring the peak, when conduit volume originations exceeded $200 billion in a single year, the average annual CMBS volume during the past decade ranged from $80 billion to $100 billion.
But when the music stopped in 2008 and conduit lenders could no longer actively securitize commercial-mortgage debt, there was simply not enough capital available elsewhere to meet the commercial-property market’s financing needs.
A positive sign that we’re likely to see more CMBS conduit lending activity is many lenders have begun rehiring staff after eliminating their capital-markets lending groups just two years ago. In addition to several new lenders entering the market, established firms such as JP Morgan, Goldman Sachs, The Royal Bank of Scotland and Wells Fargo are all believed to have begun hiring and, in some cases, even lending in their revamped conduit programs.
Self-Storage Still Faces CMBS Hurdles
Though CMBS programs are returning to the market, don’t expect them to be a significant source of self-storage capital. Conduit lenders will focus first on the “low-hanging fruit” of refinance deals whose economics make them extremely attractive transactions. There’s currently a glut of these loans on lenders’ books that have been previously extended due to a general lack of available refinancing capital.
In addition, prior to purchasing new CMBS bonds, end investors will look for assurance that the collateral quality is extremely high, the lender’s underwriting is transparent and prudent, and leverage is extremely conservative. For CMBS bond pricing to again become consistent and somewhat predictable, the real estate collateral and lender underwriting must initially be generic, giving comfort and familiarity to market participants and allowing the market to first gain a foothold and then build some momentum.
Another challenge self-storage owners will encounter with CMBS programs in the near term is the government’s TALF (Term Asset-Backed Securities Loan Facility) program. Most new issuance CMBS transactions to date have used some form of the TALF to help support their transactions. However, the program includes eligibility guidelines that currently make it very difficult for self-storage loans to conform.