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.
Self-storage was not initially included as an eligible property type under the program. Recently though, Park Bridge Financial successfully obtained approval from the New York Federal Reserve to include self-storage as an eligible asset class in the TALF program. Nevertheless, costs and other factors involved with a TALF execution mostly limit the product at this point to only the largest institutional borrowers such as real estate investment trusts, Few self-storage borrowers fit the current program’s criteria.
A final hurdle storage owners face is active CMBS programs have loan size, property classification and other restrictions that do not favor self-storage economics. Most have minimum loan-size criteria of $10 million (in some cases as high as $20 million), which alone presents a major obstacle for many self-storage owners and investors.
It’s also not uncommon for lenders to limit their current CMBS offerings to retail, office and industrial properties given their familiarity and expertise with these asset classes and the sheer volume of transactions available. Over time, these restrictions will become less onerous, as additional capital providers enter the space and lending competition increases.
The good news is that as CMBS lenders and insurance companies begin to lend again in earnest, the liquidity they present to the market will take pressure off the system down the line, freeing up capital at the regional and local bank level. With CMBS lenders providing a much-needed outlet for larger financing transactions, local and regional banks will once again be able to concentrate on a greater number of borrowers, such as storage property owners, with smaller loan needs.
Hard-Fought Victories Bode Well Long-Term
Despite that it may take time for CMBS capital to make itself available to mainstream self-storage borrowers, our industry has achieved two hard-fought victories during this current recession and period of unprecedented illiquidity. First, the government’s willingness to analyze and accept self-storage as a TALF-eligible property type validates storage as an acceptable asset class for all institutional investors. Second, self-storage has outperformed all other property types in terms of CMBS loan delinquency rates throughout the recession; a fact that will surely resonate with lenders and investors as financing markets improve during the next several years.
Each individual battle victory helps put self-storage on equal financing footing with better-known commercial-property types. Thanks to these achievements, we expect lenders will be more willing to include the storage-asset class in their product mix going forward, which is a positive trend for self-storage investors given the rocky roads they’ve been forced to travel in recent years.
Shawn Hill is a principal at Chicago-based The BSC Group, where he provides mortgage-brokerage and financial-consulting solutions to self-storage and other commercial real estate owners nationwide. He can be reached at 773.517.8504; e-mail [email protected].