WASHINGTON, DC—From the depths of the 2008 global financial crisis, many sectors of commercial real estate have recovered nicely, and “nearly every major financial index in the US has recovered to levels that are better than pre-crisis levels,” writes Ed Shugrue, CEO of Talmage LLC. However, CRE debt, and specifically CMBS, continues to lag, Shugrue writes in the latest issue of CRE Finance World, published by the CRE Finance Council.
Even so, Shugrue sees it as a promising investment vehicle. “Until the $360 billion of maturing CMBS debt is resolved with some clarity and/or the CMBS market can grow to closer to $1 trillion in size (thereby affording broader research and trading support), we see CMBS as a compelling field of investment able to provide a wide array of investors access to returns that range from core to opportunistic, from AAA to CCC, and from six months to 30 years,” he writes. “What we find particularly compelling about CMBS is the ability for investors to customize investments to fulfill very specific risk/reward parameters for a particular asset.”
Many of the CMBS loans, from the 2005 through 2007 vintages, were aggressively underwritten during a particularly overheated time in the capital markets, writes Shugrue.? As a result, loss severity for these maturing loans is poised to exceed the 42% historical average.
“Significant losses have yet to be realized in the $360 billion of CMBS loans that are maturing in the short-to-medium term,” he cautions. “Due to adverse selection and the aggressive underwriting of the 2006-2007 vintages, we estimate loss severities of 50% to 100% greater than historical norms. However, we anticipate that while the average loss severity could be as high as double historic levels, it will be highly concentrated and by no means ‘across the board.’”
The uncertainty attending the ultimate ownership, loss experience and resolution of these maturing loans “is weighing down the CMBS recovery and, in part, preventing the CMBS market from expanding beyond its current size of approximately $570 billion,” Shugrue adds.? However, potential remains for cautious investors to make rewarding deals.
“While impossible to accurately forecast which subsectors within CMBS will provide the greatest absolute or relative returns at a particular moment, the CMBS space will provide outsized returns for dedicated investors who are able to invest opportunistically across the capital structure and across various CMBS sectors nimbly for the next four years,” writes Shugrue. “In addition to comparatively outsized returns, CMBS rewards investors with its liquidity and current income.”
Furthermore, these investors can find many ways to play in the CMBS space. Some of these plays include new issue CMBS, whole loans, legacy CMBS, floating rate loans, CDOs and the B-pieces of CMBS pools. “By closely following these various sectors, capital can be effectively allocated to where the opportunity is most attractive or out of line with historical norms for fundamental or technical reasons,” he advises.