Recovering CMBS Market Hits Rough Patch: With the Prospect of Commercial Real Estate Transaction Reaching $200 Billion in 2011, the Market May Not Be Able to Expand Further without Mortgage-Backed Securities (CMBS) as a Lending Source. Even So, Capital Markets Volatility Became an Issue in Late Summer, Clouding the Outlook for the Rest of the Year

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Although volatility in the capital markets over the summer--especially following the downgrade of U.S. Treasuries on Aug. 5--has spooked commercial mortgage-backed securities (CMBS) market participants, this financing source is definitely back, say experts, while not as strong as anticipated earlier in the year. * In 2011, new CMBS issuance may not top $30 billion, far below estimates of $30 billion to $50 billion early in the year. Still, anywhere from $5 billion to $8 billion was in the CMBS pipeline as of the end of August. However, after October, that pipeline will be sparse until the end of the year, possibly picking up after that, says E.J. Burke, executive vice president, group head, at Key Bank Real Estate Capital, Cleveland, who also serves on the Mortgage Bankers Association's (MBA's) Commercial Real Estate / Multifamily Finance Board of Governors (COMBOG). Burke is also MBA vice chairman.* "The CMBS market provides an important source of capital for commercial real estate," says Dan Fasulo, managing director at Real Capital Analytics Inc. (RCA), New York. He adds, "We have seen a significant recovery in commercial real estate transaction activity and we will probably do $200 billion in deals in 2011." * This is the biggest volume since the beginning of the financial crisis, and it would be comparable with deal volume in 2004, he says. (The volume for the first half of 2011 was $90.6 billion--a 104 percent increase over the first half of 2010, according to RCA research.) * "With this volume, we are getting close to the point where the market cannot continue to expand without the help of the CMBS sector, because pension funds and insurance companies have finite pools to invest. We need the public markets to expand," says Fasulo.


And there are other reasons that the CMBS market is needed, says Fasulo: "As long as interest rates are low in major Western economies, investors need a higher-yielding asset class so they can put their money to work." He expects to see about $35 billion in new CMBS issuance for all of 2011.

Still, because of fears about the larger economy, in the United States as well as Europe, says Tom Fink, senior vice president, managing director at Trepp LLC, a New York-based commercial real estate research firm, spreads on conduit loans (which began to widen in late summer) are expected to stay wide for a while.

As a result, "people are having trouble doing loans that make sense for securitization," he says. While wider spreads may entice investors, the higher coupons could discourage borrowers, says Fink. At the same time, volatility in the market makes it hard to hedge interest-rate risk. All of this together could be cutting into demand for CMBS loans, he says.

And there are other factors cutting into the demand for CMBS, says Darrell Wheeler, senior managing director at Amherst Securities LP, New York.

"The reality is that there will not be a lot of mortgage maturities until 2015, so the CMBS market will be much smaller than it had been before the crisis for the next couple of years. Mortgages have to mature before originators can do new originations," he says.

"We get new mortgages from people selling properties, but the major driver is refinancing and the majority of refinancing will not happen until 2015," notes Wheeler.

CMBS vs. other lenders

"CMBS has a smaller proportion of commercial real estate originations than at the height of the market in 2007, when it accounted for over 50 percent of the volume of new originations," says Ben Carlos Thypin, director of market analysis at RCA.

"In 2011, as of the end of August, CMBS made up about 21 percent of commercial real estate origination volume--slightly down from 26 percent for all of 2010, but higher than in 2009 when it accounted for only 10 percent of commercial real estate originations."

CMBS competes with a variety of lending sources, including foreign and domestic banks, thrifts, life insurance companies, and Fannie Mae and Freddie Mac, with the last two sources only competing in the multifamily arena. …


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