The Resurrection of CMBS

NEW YORK CITY-Reports that the Royal Bank of Scotland is preparing a $500-million CMBS bond deal, the first of 2010, bode well for the near term, experts tell GlobeSt.com. “It’s a good harbinger for what we are expecting and hoping is a recovery in commercial real estate lending,” says Patrick Sargent, president of the Commercial Real Estate Finance Council. In particular, Sargent tells GlobeSt.com that the multiple-borrower nature of this issue, in contrast to the handful of single-borrower deals that occurred at the end of 2009, augurs a return to “more of the traditional conduit-type lending.”

However, the deal flow that emits from the spigot this year is not going to compare in volume to what the industry experienced in 2007, when sales reached $232.4 billion. “We’re not going back to a $200-billion-a-year market,” Tom Fink, managing director of Trepp LLC, tells GlobeSt.com. “But $20 billion to $30 billion of new-issue CMBS this year would be a huge step in the right direction. Given the amount of time it takes to get a deal done start to finish, the fact that they’re able to put together a deal this early in the year bodes well for the market.”

That still-developing market for new CMBS coexists with the continuing fallout of the pre-2008 market. In its monthly CMBS delinquency report issued earlier this week, Realpoint LLC said the default rate had reached 6% in February, with the unpaid balance nearing of overdue loans near $48 billion. Seventy-seven percent of that tally was originated between 2005 and ’07, according to Realpoint. Yet this appears not to be shaking investor confidence for new-issue securities.

“What I’ve heard from both lenders and investors is that loans made in the next two or three years are some of the best commercial real estate loans made in a long time,” says Fink. He points out that the CMBS deals that originate this year will be relatively low risk over the long term. “Does that mean that all of these loans will outperform expectations and none will go delinquent? Of course not; this is still real estate and every piece of real estate has its own idiosyncrasies that can affect performance.”

Mitigating that element of unpredictability is more conservative underwriting. Sargent points out, “Having been through the past two years, investors are demanding it, and loan originators and others in the process realize that this is the only way that loans are going to get made.”

Fink concurs, saying, “Everybody’s going back to basics right now. It has to be loans that make sense in the current market environment and not based on a pro forma underwriting or an expectation that they’re going to be able to execute some complicated business strategy in order to get the loans up to the level they need to make debt service coverage.” CMBS loans issued today, he says, will “have to come out of the box, being able to pay their debt service with sufficient margin that the lender is comfortable to make the loan.”

Sargent says the lower-risk nature of the new-issue CMBS deals is increasing investor comfort as well. He notes that the late ’09 offerings that began with Developers Diversified Realty Corp.’s $400-million deal through TALF were “well subscribed,” and adds, “there’s a lot of money out there waiting.”

Potential CMBS investors, says Sargent, fall into two camps. “One is the folks who thought they would be able to put together a fund, go out and be opportunistic and get yields in the 20s,” he says. “The second kind is the people who are just looking for straight real estate mortgage investments. They just want prudent underwriting and low risk, and they’ll take a more modest return.”

A spokesman for RBS tells GlobeSt.com his company has no comment on Wednesday’s Wall Street Journal story reporting the forthcoming CMBS issue. He adds, however, that structured real estate lending is “a non-core business” for RBS and the bank is not engaged in originating commercial real estate loans for its balance sheet.