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REAL ESTATE MERCHANT BANKING
Commercial Mortgage Backed Securities (“CMBS”) is having a banner year in terms of originations. Through the first half of the year Lenders have securitized $42.29 Billion (1) of loans surpassing the total securitization volume in 2023.
There are multiple factors that are driving CMBS demand but first allow me to provide some context. CMBS, borne out of the residential mortgage-backed securities market, gained prominence and market foothold in the late 90’s and expanded rapidly to dominate commercial real estate financing by early 2000’s up until the Great Financial Crisis of 2008 and the eventual collapse of Leman Brothers and Bear Stearns.
The CMBS loan product was intended to finance stabilized cash-flowing commercial real estate. However, buoyed by the fact that the risk/exposure of the B-Piece – sub-investment grade security — could be sold off to other investors, CMBS soon became stretched to its limits. These “lenderless loans” were now being used to finance everything from non-cash flowing properties with lease up risk to reposition plays.
The aftermath of the financial markets collapse saw CMBS delinquency rates soar and more importantly borrowers became disenchanted with the lending product having had difficulty in working with the loan servicers to address everything from simple loan approvals through a proposed loan restructuring. In the decade that followed. CMBS never reached the securitization volumes the market saw in 05’-07’, primarily because of the lack of Borrower appreciation for the loan product, until now.
With the implementation of Dodd-Frank, and associated risk-retention rules, originators returned to focusing once again financing sound real estate deals.
The factors driving CMBS financing are the exact ones that make the loan product unique.
• A property-first focus
• Fixed-rate
• Property type agnostic
• Origination flexibility
Property first focus: As Borrowers/Sponsors today face multiple challenges from the lingering effect of the Covid shutdowns and the 21’/22’ multifamily transaction bubble, personal credit has deteriorated. That has caused lenders, especially Banks and Agencies, to tighten their Sponsor credit box and turn down loans for Borrowers with an imperfect credit record. CMBS lenders are primarily focused on the property and its ability to maintain or increase cashflow overtime and therefore sponsor quality can range.
Fixed Rate: As short-term rates, driven up by the Fed, have eclipsed long term rates (yield curve inversion) borrowing long term has become significantly cheaper than borrowing short term.
Property Type Agnostic: One of the hallmarks of CMBS lending is the ability to finance all CRE product. When lenders and investors thought retail centers were going away, CMBS financed the sector. Today a similar sentiment is being attached to Office, but like with retail centers in the past, CMBS is again stepping in and financing the sector.
Origination Flexibility: One of the most significant of “features” CMBS lenders can provide is structural and pricing flexibility at origination. On the structure side, full term interest only loans are available at relatively high LTVs as well the ability to pay origination fees to offset interest rate spreads. which in turn increase loan proceeds as most loans are debt service coverage constrained in the current environment.
With seemingly unlimited lending capacity CMBS is poised to originate more than $100B of loans this year, a level not reached since 2004. This boost of liquidity in the CRE debt market is helping to stabilize the CRE market and provide it capital to grow.