Late last year, bankers began marketing the largest issuance of commercial mortgage bonds since the start of the financial crisis. Hilton Worldwide, the massive hotel chain that recently went public, marketed $3.5 billion in these structured bonds in November as part of a larger debt-financing package. The deal represents a star turn for a market that was completely frozen just a handful of years ago.
Commercial mortgage bonds, officially known as commercial mortgage-backed securities, or CMBS for short, are bonds that are backed by pools of commercial mortgages. Real estate insiders closely monitor these bonds’ performance, since they are an indicator of the industry’s access to financing.
“It is a barometer for the health of the overall market,” said Shawn Rosenthal, an executive vice president at the mortgage brokerage firm CBRE. “When it is doing well it means that lenders have to be more competitive, investors are buying the bonds, and we are in a healthy environment.”
The CMBS market was a darling of the real estate bubble, with some $230 billion in bonds issued at the peak in 2007. But by 2009, investors had fled the market and lenders had mostly closed up shop, so not a single bond was issued. Since plummeting to its nadir, however, the CMBS market has been slowly clawing its way back to pre-crash levels.
Dubbed CMBS 2.0, some $90 billion worth of these commercial mortgage bonds is expected to be issued this year, a nearly 100 percent increase over last year, according to research from Trepp, a market analysis firm. Next year, Trepp estimates that CMBS issuance could reach $100 billion, while others say that figure could top $120 billion.
The bankers who are creating CMBS issuances include diverse loans in the bond pools as a way of mitigating risk. So a single bond may include mortgages for office buildings, hotels, multifamily properties, and retail stores, in a variety of locations, including major cities and smaller markets. Real estate insiders, including developers and architects, keep close tabs on CMBS: As investor demand for these bonds grows, bankers can include increasingly diversified—and often riskier—properties in the pools of loans. So it may be easier to obtain a mortgage on a skyscraper in New York City or a rental building in a prime Chicago neighborhood. And as the CMBS market expands even further, owners of less prestigious properties—an Arkansas mall, say—will also have an easier time getting a loan.
“There is no question that 2014 is going to be a big year,” says Douglas Harmon, an investment sales broker at Eastdil Secured. “In New York and other gateway markets, there are a lot of lenders that cannot seem to get enough real estate exposure. Look how many projects are on the docket,” he adds, noting the Hudson Yards office project in Manhattan and numerous condominiums under construction along West 57th Street. “There are more projects that are in the planning stages than there has been in a decade.”
As demand for CMBS grows, more lenders are entering the market and competing with one another to make loans. “Three years ago, banks were hoarding money,” said Dan E. Gorczycki, a managing director with real estate brokerage firm Savills, “and 18 months ago, they had the money, but they were reserving it for existing clients. These days, they have money for new clients, but it has to be a high-quality deal, and they want them to become customers as quid pro quo for doing the loan.”
One recent example that shows how lenders are taking on more risk is Spain-based Banco Santander’s $117 million loan to Ares Management, Tucker Companies, and Kushner Real Estate Group for a low-rise residential-and-retail complex that the three partners are building in Fort Lee, N.J. “It is a rare case where you can get a loan for a retail and multifamily development that is still under construction and hasn’t yet been leased,” says Gorczycki, whose firm coordinated the loan. “But the reality is, this is a high-quality borrower, it is a bulletproof market, and there is very little risk that it won’t lease up.”
Nevertheless, there are some red flags in the CMBS market. A chief concern is the wave of bonds that are set to mature over the next several years. There is $110 billion worth of 10-year CMBS bonds expected to mature in both 2016 and in 2017, according to Trepp. These loans were underwritten at the height of the real estate bubble when standards were often at their riskiest. As a result, many of the underlying real estate assets in the bonds are highly leveraged and are located in smaller markets that are still struggling.
Despite concerns over this wave of impending maturities, “the hope is that by the time we get there, the economy will have continued to grow, and the fundamental performance of these properties will have improved,” says Joe McBride, a research analyst at Trepp. If the market is stronger by then, credit should be available and borrowers should be able to pay off the debt or refinance the loans, he says.
Another factor that will be closely watched in the coming year is underwriting standards. As more lenders get into the game and competition continues to intensify, some experts say that standards may start to slip. This is a major worry, because it was loose underwriting standards last time around that drove many investors from the CMBS market.
In particular, because CMBS is made up of several different property types, the market is keeping an eye on whether some bonds may have a heavier weighting toward riskier properties. And they are also keeping an eye on how much leverage is on these properties. Before the crisis, many properties were as much as 85 percent or even 90 percent leveraged. That fell precipitously after the market crash, when loans were harder to come by, and even high-quality borrowers had a hard time obtaining more than 60 percent financing for a project. Now some deals are as much as 75 percent leveraged. “Lenders are getting more aggressive, they are looking the other way at things that used to be scrutinized,” Gorczycki says.
“CMBS underwriting is fair; they aren’t pushing the envelope like in 2005, 2006, and 2007,” Rosenthal says. Still, competition can quickly devolve into loosening of standards. “That is how it happens—one guy does something at one bank to win a loan and then all of a sudden that becomes the new market norm,” he says. “So that competitive nature is definitely something to think about in 2014: what banks are willing to do to win those loans and how to keep the standards as strong as they have been.”
Meet Your New Commercial Mortgage Lender: Metlife
There have been a number of new entrants into the commercial loan market in recent years, including a growing appetite from life insurance companies. These firms typically eschew riskier, shorter-term loans, but they have been increasingly stepping up to the plate. In November, for example, MetLife agreed to originate $500 million of a $1 billion mortgage for the Blackstone Group on 1095 Avenue of the Americas, a Midtown Manhattan skyscraper that it owns. The mortgage has a term of up to five years.
“Life companies are a large part of the equation these days,” says Shawn Rosenthal, a senior executive at mortgage brokerage firm CBRE. “Their loans tend to be more conservative, with longer terms of 10- to 15-years, although some are now doing shorter-term loans, particularly in markets like New York City.”
The MetLife loan is important because it highlights how some insurers are more willing to take on larger loans. “In general, a big change between the end of 2012 and the end for 2013 is how large a loan a specific institution is willing to hold on its own,” Rosenthal says, adding that many lenders used to consider $100 million the maximum they would lend, but that this cap has been steadily pushed upwards.
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