In a market where there is abundant debt capital chasing too few deals, CRE-CLO and single-asset, single-borrower (SASB) finance originations are both on healthy paces. The activity in both categories helped lift CMBS issuance during the first half of the year to $67 billion, which is already ahead of the full year total of $64 billion in 2020 and on course to surpass the $115 billion that occurred in 2019, according to Trepp. “Overall, that’s a very strong number given what we have faced over the last 18 months,” says Darren King, vice president, CMBS product management at Trepp.
Digging into those numbers further underscores the shift in where dollars are flowing within the CMBS universe. Conduit activity is more subdued with $14.7 billion in issuance so far in 2021—a significant drop compared to average volumes from 2017 to 2019, which typically came in at around $45 billion per year. At the same time, CRE-CLO and SASB activity are both on the rise. CRE-CLO issuance has exceeded $20 billion for the year, already beating the previous high in 2019 of $19.5 billion for the full year. SASB issuance, meanwhile, reached $31 billion at midyear, which puts that segment on pace to exceed the high of $46 billion in issuance in 2019, according to Trepp.
What’s driving the shift in what CMBS deals are getting completed? Observers say the drop in conduit volume is not surprising considering the distress and uncertainty that has surfaced during to the pandemic. Market participants are more cautious on properties they are willing to lend against, particularly in the hardest hit sectors of hotels, retail, and, to some extent, office, says King. All three of those sectors have seen less issuance, and it is especially noticeable in issuance volume as office and retail have traditionally been the two most dominant property types in conduit CMBS loans, he adds.
The composition of CMBS issuance has deviated from traditional patterns, agrees Joseph Baksic, assistant managing director in the structured finance group at Moody’s Investors Service. “Right now, that dislocation has been exaggerated to a point that we have never seen before,” he says. The conduit space has faced multiple challenges over the past 16 to 18 months. One is that there is less deal flow due to the pandemic, particularly for retail and hotels. At the same time, there are many alternative sources of liquidity in the market, and borrowers that are looking for non-recourse capital are finding it from other sources, including bank and non-bank lenders, as well as CRE-CLOs, notes Baksic.
The big advantages that CMBS conduit loans have offered borrowers in the past were higher leverage, non-recourse financing. CMBS lenders continue to offer competitive rates at about 4 percent. However, CMBS lenders have pulled back on leverage, which takes away some of the incentive for borrowers. In addition, CMBS has always been challenged by the borrower and lender dynamic. Once a pool of loans is securitized, a borrower has traditionally run into more challenges managing their properties, given the approvals required. So, that could be pushing some borrowers to consider other capital sources, adds Baksic.
Record growth for CRE-CLO
The CRE-CLO market is getting a boost from a variety of different factors. CRE-CLO is generally short-term, floating rate debt that is well-suited for properties in transition. The majority of the collateral backing these loans is multifamily, and the huge demand for housing has fueled demand for financing to support value-add repositioning and new construction take-out. Borrowers also like the flexibility of CRE-CLO loans, which are typically 2-4 years, with extensions, and easy to pre-pay.
How CRE-CLO financing works is that it has two levels – the initial funding and a future funding component that takes the loan through the path of stabilization. The borrower only pays debt service as it is funded. As the borrower makes improvements or gets leases signed, they draw on that future funding amount. That helps them cover their debt service and gives them more flexibility on multiple fronts to realize their business plan should it be revised and refined, notes Deryk Meherik, senior vice president in the Structured Finance Group at Moody’s Investors Service. “That has been one of the main attractive features of this type of product for borrowers,” he says.
The rise in CRE-CLO volume also is due to more investor capital entering the space. “The investor base has expanded dramatically. So, not only are there more traditional CMBS investors that have allocations for CRE-CLO, but there also are traditionally corporate CRE-CLO investors,” says Meherik. The pricing on CRE-CLO loans has come down significantly , which shows the investor confidence and interest in CRE CLOs, he says.
It also is important to note that the lender or issuer keeps the bottom 10-20 percent of the transaction. “They have the most skin in the game of any CMBS product,” says King. That means those lenders are writing loans that they are very comfortable with keeping. So, it’s not just a case of, “let’s grow this because there is good demand for it.” The growth occurring is healthy, because there is good collateral and credit quality backing loans, he says.
Large deals drive SASB issuance
SASB loans were on the rise prior to the pandemic and have continued to follow that same path. The sector has seen some major deals close during the first half. Notably, Blackstone and Starwood went to the SASB market to finance their acquisition of Extended Stay America. The $4.65 billion Extended Stay deal, known as ESA 2021-ESH, is the second largest transaction done since the financial crisis, according to Trepp.
The single asset side of the market leans toward very large, Class A assets with institutional quality sponsors that can range into the hundreds of millions of dollars, and even billions in terms of size. Investors also like the SASB space as they are getting their arms around one single asset. Although conduits include a pool of loans that offers diversity, investors often have to be comfortable with all of the assets in the pool, notes King. It also is notable that there is good liquidity across property types, with SASB loans getting done on hotel, office and even retail malls, he adds.
The uncertainty related to the impact of the Delta Variant likely will continue to put a damper on CMBS conduit issuance in the second half of the year, while both borrower demand and investor appetite for CRE-CLO and SASB product remains strong. “Uncertainty is the enemy in these asset classes. Even if the outcome isn’t the ideal that we had hoped it would be, if you remove the uncertainty factor, I think you will start to see more growth,” says King.
