The Future Of CMBS - Is There One? Absolutely!

Doug Marshall
Market Assessment
Published July 28, 2009

In our daily business of mortgage brokering and facilitating commercial real estate loans, we have been hampered by large holes in our lender list.

I’m constantly reminding borrowers that sectors of the lending market that would have aided them in past years are gone – just gone – and we don’t know if they’re coming back.

One of those lending sectors, lost to us at this time, is the CMBS (commercial mortgage-backed securities) market. Shoddy securitized lending practices have been one of the primary causes of the entire credit crisis.

Its lack of oversight, furious pace, and too aggressive underwriting criteria, has driven CMBS investors to lose all faith in the process. It is no longer an option for a sane, rational investor.

But what of the future? Does the CMBS market stand a chance of returning? Yes, unequivocally, says Adam Klingher of Johnson Capital. “Lending has gotten too big to do it the old way with banks and insurance companies taking in money and then lending it out the back door…”

As long as the issuer can show they are really underwriting their loans and making “good investment decisions, the security investors will return,” says Klingher.

But how will it re-emerge with any credibility? That’s the real question. How will the CMBS market convince security investors that it has learned its lesson, so to speak, and can be trusted not to occasion a similar crash and crunch in future years? What changes to its customary ways will it have to make?

Correcting the present CMBS approach to financing commercial real estate will require a sharing of the financial risk between the issuer and the investor. “The huge bonuses Goldman Sachs will soon hand out shows that the financial industry high fliers are still operating under the system of heads they win, tails other people lose,” says Paul Krugman at the New York Times.

Under the present system if a bank generates big short-term profits by securitizing and selling their loans, they get lavishly rewarded – and they don’t have to give the money back even if the investors get bilked out of their life savings. That’s just plain wrong.

As Adam Klingher puts it, there is a real need for the “economic interests of the banks or originators to align with the security investors.”

The issuer needs to leave “skin in the game” so investors know that the CMBS issuer will feel the financial pain just as much as the investor if something goes horribly wrong.

Otherwise, according to Paul Krugman, they will once again have “every reason to steer investors into taking risks they don’t understand.”

This is what it’s going to take to get the CMBS market back on the road to doing business with integrity.


Sources:
"CMBS Lending – Will it Ever Come Back?" July 14, 2009 by Adam Klinger of Johnson Capital
"The Joy Of Sachs," Paul Krugman at The New York Times, Oregonian article.

Light At The End Of The Tunnel – But Not Much Sun

Doug Marshall
Market Assessment
Published July 22, 2009


Signs of economic improvements, at the moment, are small but persistent: dire economic collapse is no longer a worry; the contraction of real GDP growth is slowing; the pace of job losses is lessening…

The question now is whether we’re near the bottom of this economic downturn, or if there’s more on the horizon – another proverbial shoe dropping and catching the global economy off guard.

For some perspective on the current economic recession, Baron’s June 12th Chart of the Day illustrates the duration of all US recessions since 1900.

As the chart illustrates, the five longest recessions all began prior to 1930. The length of the current recession (now in its 20th month) is above average and the longest recession since the Great Depression.

According to Nouriel Roubini and the RGE Global Monitor, this recession, the longest and most severe of the post-War period, produced an immediate contraction in consumer confidence and economic activity. Basically, growth came to a grinding halt and then slammed into reverse.

But, while that contraction is showing signs of slowing, there are many economic indicators that are not improving fast enough to declare this recession as coming to a close.

Unemployment, industrial production, real manufacturing, wholesale retail trade sales, and real personal income are indicators that are still seen as continuing in decline.

Therefore, “RGE Global Monitor does not yet see signs of a strong and sustainable recovery.” They predict that “real GDP will stop contracting at the end of 2009, but it is likely that many of these indicators will not bottom out before mid-2010.”

So how does this slow economic recovery affect us in the commercial real estate market? Unfortunately, it has a direct, adverse impact on the health of our industry.

Without new jobs being added into the marketplace rental rates can’t rise, vacancy rates can’t fall and property values can’t increase.

An increase in employment must precede a rebound in commercial real estate. Let’s hope that the experts are wrong as a jobless recovery would have long-term undesirable consequences for all of us.


Sources:
Wall Street Journal, July 11, 2009, Nouriel Roubini: Still Gloomy, But Sees Pace of Contraction Slowing
Barron’s Chart of the Day, June 12th.

Coming Home To Roost

Doug Marshall
Market Assessment
Published July 6, 2009

The numbers are alarming… probably because they’re simply so huge. And for some reason, the conversation about this doesn’t seem to be happening.

While most attention in commercial real estate today is focused on the dramatic deterioration in term loan performance (i.e. defaulting loans), an even more troublesome issue is the extent to which loans originated during the 2005-2007 period will encounter significant problems, refinancing at maturity.

A report dated April 22nd, from the prestigious Deutsche Bank Securities research group, focused on this refinancing issue. Shown below is a chart showing the annual maturities of loans by lender classification.
The conclusions drawn by Deutsch Bank Research are manifold, and are a great cause for unease:

· Commercial real estate prices have already plummeted 25-30% from their peak in 2007 due to the enormous changes in available financing terms (lower LTVs, higher interest rates, etc).

Further declines may be expected based purely on the degrading economy (which is resulting in higher vacancy and lower rental rates), pushing values down another 15-25%.

· The decline in commercial real estate values in the 2005-2007 period will make it very difficult for many properties to refinance when their loans come due.

They predict that two thirds of the loans maturing between 2009 and 2018 ($410 billion) are unlikely to qualify for refinancing at maturity without significant equity infusions from borrowers.

· This group estimates that the equity deficiency that would have to be made up by borrowers themselves tops $100 billion.

Solutions that have been floated to solve this problem seem, at best, naïve. One idea that has been presented is that banks and other lending institutions facing this refinancing wave will simply agree to extend the maturity dates.

This incorrectly assumes that either: 1) the lender, by shortening the amortization of the loan, will sufficiently help accelerate the pay down of the loan; or that 2) extending the loan term provides the property time to achieve additional growth in value so the loan can qualify for refinancing.

With respect to the first possibility, the report concludes that the value deficiency for many loans is far too large to be tackled by simply accelerating the amortization over a reasonable time period. And with respect to value growth, the likelihood of significant property price appreciation is remote.

It’s a gloomy forecast. We strongly encourage borrowers to determine whether any of their loans are currently “upside down.”

This can be determined simply by taking current interest rates, cap rates, and underwriting terms to calculate whether their new loan would qualify for refinancing at more or less than the existing loan amount.

If the new loan is less than the existing loan you’ve got a problem; and now is the time to start working on a solution, not when the loan is due.

If you or a client of yours would like help estimating a new loan for their property under today’s lending criteria we are ready to assist you. Please do not hesitate to contact us for a no-obligation loan estimate today.

Source:
Potential Refinancing Crisis in Commercial Real Estate, April 22, 2009, by Deutche Bank Securities, Inc.