CMBS pros have come to terms with the reality that the market will never regain the heights reached before the great financial crisis. Annual issuance volumes north of $200 billion are not in the cards. But the sector, complemented by agency-backed CMBS issuances that didn’t have much of a presence pre-crisis, has steadily built up volumes each year.
That culminated in U.S. CMBS activity surging 27 percent in 2019 with total issuance reaching $97.8 billion. The volume set a new post-recession high, edging out the $95.0 billion in issuance that occurred in 2015, according to Commercial Mortgage Alert. Early industry forecasts are anticipating more growth ahead for 2020. As recently as October experts didn’t think that would be the case, but a surge of deals in the fourth quarter pushed 2019 volumes over the top.
Trepp is predicting another 5 percent to 10 percent in growth for CMBS in 2020, which would put U.S. issuance at between $105 and $110 billion. That view is consistent with the latest data outlook survey from the Mortgage Bankers Association that expects commercial and multifamily mortgage originations to rise a further 9 percent in 2020 to total $683 billion.
Although it’s still early in the year, economic indicators still look favorable. Treasuries are firmly below 2 percent. Spread volatility remains light, and there is no significant inflationary pressure, notes Manus Clancy, a senior managing director and the leader of applied data, research and pricing at Trepp. There was no skittishness that prompted lenders to tap the brakes, because they were worried about getting their loans securitized. “You really couldn’t have asked for a more favorable set of conditions last year than issuers had,” he says.
CMBS also benefitted from the pullback in GSE lending that occurred in third quarter 2019. Fannie Mae and Freddie Mac both slowed lending because they were worried about hitting caps too quickly. CMBS issuance to multifamily was about $12 billion in 2019, which was about twice the volume of 2018, according to Commercial Mortgage Alert.
Despite what many would agree is late in the cycle, there hasn’t been any significant softening in commercial real estate fundamentals, adds Jay Wardlaw, managing director at Regions Bank Capital Markets. “We think that’s a strong positive moving into 2020, and we think the economy is going to continue to be relatively strong going into this upcoming year,” he says. Regions Bank expects CMBS issuance to be strong through first quarter with volume for the year that will likely be similar to 2019, either moving $10 billion higher or lower depending on what happens with the upcoming presidential election, he adds.
Low rates spur borrowing
Several factors that helped to lift volume in 2019 are still in play for 2020. One of the biggest factors spurring activity is incredibly low financing rates. The 10-year moved below 2 percent last year in the wake of Fed rate cuts, which resulted in CMBS loans getting done in the second half of the year at coupon rates of 3.5 percent to 3.75 percent. Those low rates allowed CMBS to compete a little bit more favorably against the insurance companies. “When rates get that low, you start losing some of the interest from life insurance companies, which CMBS traditional competes with, because the rates are not meeting certain yield thresholds,” says Clancy.
Borrowers also saw an opportunity to lock in low-rate, long-term debt for new loans, as well as refinance existing loans. “What is really hard to tell is how much growth in 2019 came from bringing maturities forward from 2020 or 2021,” says Joe Franzetti, a senior vice president at Berkadia.
The low rates did push borrowers off the fence, agrees Wardlaw. “The first half of the year was fairly similar to where it was in 2018, while in the second half of the year we really saw an increase in supply coming through our shop,” says Wardlaw. The increase in business was not necessarily at the expense of life insurance companies, but rather a shift from borrowers moving from shorter term financing, including bridge and construction loans, to long-term fixed rate loans to lock in those low rates, he says.
Coupons on CMBS loans remain at very low levels of 3.5 percent to 4.0 percent due to the combined effect from low rates and tight lender spreads. “That is very attractive for a lot of long-term owners of real estate. So, we’re seeing significant increases in our flow coming from clients within the bank, as well as referrals from our relationship managers,” says Wardlaw.
CMBS 2.0 maintains comfortable niche
CMBS has gotten to the point where it isn’t generating astronomical issuance numbers as it did prior to the great financial crisis, but it is sticking to its knitting and filling a specific market niche that will result in steady production going forward, notes Franzetti.
CMBS is a good source of capital for borrowers seeking five-year and 10-year fixed-rate loans on class-B and class-C properties, as well as very large single-asset, single borrower loans that are more challenging for other lenders to do. Both conduit and single-asset, single borrower volume saw fairly equal gains in issuance last year at about $10 billion each, according to Commercial Mortgage Alert. Other areas where CMBS lenders can find an edge over other capital sources are in offering higher levels of interest-only and financing fixed-rate loans on multifamily properties more quickly following construction completion.
CMBS also continues to have good liquidity on the investor side. There is still a tremendous amount of interest coming from the bond buyer side, because there is still a little bit of a premium with the CMBS product versus some other investment alternatives. A DBRS Morningstar report also credited the more selective underwriting standards from the Dodd-Frank risk-retention requirements for producing lower-leveraged, higher-quality properties for loans packaged in CMBS. CMBS delinquency rates also remain at historically low levels.
Moody’s recently highlighted performance for the commercial real estate market as “green” in its latest Red-Yellow-Green report on U.S. property market performance. By sector, the commercial real estate outlook is still favorable, although there are some concerns about valuations and pockets of overbuilding in multifamily and hospitality and continued challenges in retail, notes Clancy. “If we’re going to see a hiccup in the CMBS market, it feels like it will come from an outside influence,” he says.
One factor that could slow issuance would be an uptick in interest rates. However, barring any external events or geopolitical surprises, the CMBS market appears to be on a very solid course for the coming year, agrees Franzetti. The recipe for good issuance is a good economy, good transaction volume and low interest rates. “We have all of that going into 2020,” he says.
One trend ahead could be some potential changes to CMBS structure. The post-closing process tends to be a bit bumpy for borrowers, such as approvals on new leases or improvements to a property. None of that can be done in CMBS because of the real estate mortgage investment conduit (REMIC) structure, as well as the different approval processes with B-piece buyers and special servicers, notes Franzetti.
The CRE-CLO market where lenders keeps the subordinate piece is a much smoother process from a borrower perspective. In theory, the structure that works for CRE-CLO short-term bridge loans could be applied to a 10-year fixed-rate CMBS loan. It hasn’t yet, but one area to watch is whether CMBS loans might start to adopt some of the CRE-CLO structure in the future as it makes for a better borrower experience, adds Franzetti.
