Dislodgement of Commercial Real Estate Public Debt Markets: The Case of U.S. and Australia
Chikolwa, Bwembya, Journal of Real Estate Portfolio Management
Executive Summary. This paper investigates whether there are any discernible trends in the U.S. and Australian commercial real estate public debt markets with the onset of the global financial crisis and the impact of subdued activity in these financing instruments on the commercial real estate market. An interpretive historical approach is used to review commercial mortgage-backed securities and unsecured bonds issued by real estate investment trusts for the period 2000 to 2009:Q3.
Commercial mortgage-backed securities (CMBS) and unsecured bonds issued by equity real estate investment trusts (REITs) are vehicles that connect the public global fixed income market with the real estate capital markets. Bonds provide an important mechanism by which firms obtain new funds to finance new and continuing activities and projects. Bond issuance has been recognized by REITs as an important debt funding tool. A range of sophisticated debt products, including CMBS, REITs unsecured bonds, hybrids and off-balance sheet financing have been used by Australian real estate investment trusts (A-REITs) (Chikolwa, 2008a). The stature of CMBS, with a range of subordination, is further reinforced as being essential for broadening the investor base in real estate debt markets and reducing the commercial real estate sector's dependence on bank financing (Reserve Bank of Australia, 2006).
The global commercial real estate market was estimated at U.S. $12 trillion at the end of 2008, of which 58% was the commercial real estate debt market (RREEF Research, 2009a). DTZ (2009) estimated that debt accounted for 70% of the U.S. commercial real estate market and that 20% of it was CMBS. An earlier study by Higgins (2007) had put the Australian commercial real estate market at nearly AU $305 billion and delineated its composition as equity 67% and debt 33%. J Chikolwa (2007) and Fitch Ratings (2007) showed the Australian CMBS market to be around 7% of the total AU $70 billion structured finance market at the end of 2006.
As such, the purpose of this paper is to investigate if there are any discernible trends in the U.S. and Australian commercial real estate public debt markets with the onset of the global financial crisis (GFC). Given the stature of commercial real estate markets and the significant role that debt plays in their operation and development, the GFC has resulted in ceasing or contraction of commercial real estate public debt markets. Some of the evident results are fewer commercial real estate transactions, both within countries and across borders; abandonment or postponement of development projects; increased bankruptcies and delinquencies; and distress asset sales to pay down debt.
U.S. CMBS Market 1990-2009:Q2
The U.S. has been leading the way in global issuance of CMBS. For the period 1990 to 2009:Q2, CMBSs totaling over AU $1,394.1 billion (U.S. $1,233.7 trillion)2 had been issued in the U.S. Exhibit 1 shows the total amount of CMBS issuance per year since 1990.
Although the U.S. CMBS issuance rose from AU $3.8 billion (U.S. $3.4 billion) in 1990 to AU $260 billion (U.S. $230 billion) in 2007, the market drastically fell to AU $13.7 billion (US. $12.1 billion) in 2008 and AU $722.3 million (U.S. $639 million) in 2009, respectively, due to turmoil in the financial markets alluded to earlier.
Exhibit 2 shows over U.S. $1,769 billion worth of CMBS are set to mature between 2009 and 2018. With the current GFC, refinancing maturing CMBS is a major concern as most credit markets are currently either shut or operating at dramatically reduced levels. Deutsche Bank (2009) notes that at least two-thirds of the loans maturing between 2009 and 2018 (U.S. $410 billion) are unlikely to qualify for refinancing at maturity without significant equity infusions from borrowers and that for the 2007 vintage, well in excess of 80% of the loans are unlikely to qualify.
U.S. CMBS Pricing
Historically, conduit transactions have had strong investor appeal as evidenced by contraction in spreads until July 2007. …