CMBS Market Thaws But With More Conservative Underwriting

The CMBS market appears to be thawing after slumping earlier this year on the heels of several interest rate hikes — but the new conduit deals pricing in August may portend more conservative underwriting for the foreseeable future.

An analysis by Moody’s Analytics CRE notes that while “third quarter deals so far are a small universe,” with two deals totaling $1.84 billion),”there are some subtle shifts to note within this small universe.” To start, says Moody’s David Salz, the percentage of multifamily loans decreased from 12% to 6%, while the percentage of hospitality loans increased from 1% to 9%.

“The decline in the multifamily percentage may be explained by more of the multifamily loans being securitized as part of CRE CLOs than in CMBS. But the hospitality increase was unexpected given the risks associated with the hospitality sector, implying that the underwriting metrics may have been much stronger,” Salz says, noting that hospitality and retail loans had the strongest movement towards more conservative underwriting standards.

Moody’s CMBS loan data indicates that the average debt yield for retail and hospitality loans increased by more than two percent each compared to the second quarter, with the the average LTV for hospitality loans decreasing by more than five percent.  Meanwhile, the average LTV for retail loans decreased by nearly 10 percent.

“The more conservative underwriting for these two property types is a function of cloudier outlooks in those sectors, and these metrics may constrain future lending to these borrowers,” Salz says.

Office loans also exhibited a move toward more conservative underwriting standards, with the average debt yield, cap rate, and loan coupon ticking up faster than other asset classes. Multifamily, industrial and mixed use properties showed smaller shifts, with the average debt yields and LTVs for industrial and mixed use loans trending lower in the new conduit deals than the second quarter averages. Salz also says multifamily was the only property type where the average loan coupon declined in Q3.

“With regard to industrial and multifamily properties, the relatively less conservative underwriting standards for these property types reflect greater perceived stability in these sectors,” he notes. “The mixed use loans’ characteristics are a function of a smaller set of loans and their property uses.”

Salz also points out that in the two new conduit deals, the average loan coupon was substantially higher than the Q2 average for every property type except multifamily, which still posted average loan coupons that were 50 bps higher than Q4 2021 and Q1 2022 averages.  Shifts in loan leverage levels were also highly dependent on asset class, with the average debt yields in the new conduit deals for hospitality, retail, and office loans up significantly over the Q2 average and decreasing for multifamily, industrial, mixed use, and self-storage loans.

Salz ultimately calls the two recently priced CMBS conduit deals “key bellwethers for market sentiment,” noting that even as loan coupons went higher for nearly all property types showed that the hospitality, retail, and office sectors faced more pressure than others.

“The result was that lenders and investors are seeking higher debt yields and loan coupons with lower LTVs for these property types,” Salz says. “The underlying loans in the new conduit deals were originated during the last few months and reflect the interest rate and other economic shocks from earlier this year. Conduit issuance shows renewed stability in the market and sets the stage for loan origination going forward. Underwriting characteristics will continue to track interest rate increases, but to the extent that inflation stabilizes and leads to smaller interest rate increases, those changes should be more measured going forward. As the economic environment evolves, it will be key to review the loans that are struggling to meet the new metrics.”