CMBS are securitizations of mortgage loans backed by commercial real estate. Created in the late ‘80s, they have gained notable momentum in the self-storage industry. Essentially, they are a means for investors to participate in the ownership of commercial mortgages. Apartment buildings, shopping or strip malls, office buildings, hotels, industrial buildings and self-storage, among other commercial property types, secure loans that serve as CMBS collateral.
"Some are calling the sub-prime problem the 'elephant in the room,' and many investors are getting nervous about aggressive underwriting practices," said Michael A. Mele, senior investment associate of the Mele Storage Group. "This could be a blow to self-storage investors because the spreads had narrowed and CMBS was becoming an attractive long-term financing alternative."
A late February meltdown of the sub-prime market may have caused those once-attractive spreads to increase across fixed-income markets, according to BridgePointe. Current market conditions are likely to lead to more stringent loan underwriting requirements in the future. AAA investors who did not typically scrutinize the collateral of CMBS deals are now beginning to do so, and low-quality loans are being removed from the pool. The weakened quality of loan underwriting has restricted the percentage of CMBS bonds that qualify for the low-cost AAA ratings. The demand for credit-default swaps is rising and, at the same time, the market is cooling to interest-only loans.
"Call it a perfect storm," said Mele, who is also president of the Florida Self Storage Association. "Market conditions mean CMBS lenders could be looking at lower profits or even losses on their current loans. That requires an adjustment, but the good news is the CMBS market is not falling apart. News headlines tell of many big deals being done. Savvy investors will consider market conditions, though, when approaching new deals."
BridgePointe cites several implications for owners, sellers and investors. With the public market exposure of the commercial real estate market, for example, it is vital for owners and investors to monitor supply and demand factors in the overall capital markets arena because any disruptions will filter through to real estate participants.
"Lenders will be more conservative in loan underwriting, focusing less on projected income, increasing amortizations, and requiring more equity. As a result, borrowing costs will increase and available loan proceeds will decrease. As a seller, it is important to understand which lender your buyer is currently working with and the potential for a loan retrade," said Gary T. Sakaly, managing partner of BridgePointe.
Sakaly also noted that not all lenders are the same. The CBMS lending market is bifurcated. Some CMBS lenders are in better shape than others and less likely to increase spends, whereas others have significant exposure and will have to increase spends. Sellers, he added, should question investors whose pricing is dependent on an interest only structure.
The Mele Storage Group has sold more than 70 self-storage properties totaling more than $300 million in sales. Each member of the group is a specialist in the fields of financial analysis, market research, contract management and marketing.
With more than 1,100 investment professionals in offices nationwide, Encino, Calif.-based Marcus & Millichap is the largest commercial real estate brokerage in the nation focusing exclusively on real estate investments. In 2006, the firm closed more than $22 billion in transactions.