This headline on US CRE financing went a bit over the top

John Greenman

Letter from Denver

As some of you already know, I’m Genevieve’s new International Real Estate Partner at TransEconomics. This is my first blog entry at La Carpeta Negra. It’s a privilege to be on board!

My comments today pertain to a February Wall Street Journal article, Warning Light Flashes for the Commercial Property Boom($), that discusses what some analysts and industry participants are taking to be warning signs signaling the emergence of some U.S. commercial real estate financing stress.

Let me first quote context from the article:

By Serena Ng

Updated Feb. 16, 2016 6:19 p.m. ET

The financial engine of the market for office buildings, hotels and malls is showing signs of strain, raising questions about the resilience of the commercial real-estate boom.

Bonds backed by commercial-real-estate loans have weakened significantly since the start of the year amid concerns of an economic slowdown. Risk premiums on some slices of commercial-mortgage-backed securities have jumped 2.75 percentage points since Jan. 1, a move that translates into a roughly 18% drop in prices for triple-B-rated bonds, according to data from Deutsche Bank AG.

The sharp move could make it harder for buyers to keep paying ever-higher prices in a market regulators already caution could be overheating. It is also causing a lot of head scratching on Wall Street. Real-estate prices are at or near record highs in many parts of the U.S., and loan delinquency rates are low.

The sector doesn’t have much exposure to oil and energy companies, the focus of a lot of the recent market distress.

Yet investors in some cases are demanding to be paid as much to take on CMBS risk as they are to take on corporate junk bonds. Property owners and developers now are facing the prospect of higher rates on loans, tougher refinancings and diminished property values as debt issuance slows and financing becomes more expensive. Citing tighter financial conditions, Morgan Stanley analysts on Tuesday said they now expect no appreciation in the price of commercial real estate this year, “with risk to the downside.” They had earlier forecast gains of 5%.

Close to $200 billion in real-estate loans that have been bundled into securities are scheduled to mature this year and next, and most need to be refinanced, according to Trepp LLC, a real-estate data service.


The $600 billion CMBS market accounts for around a quarter of all U.S. commercial-real-estate loans. Wall Street repackages loans made to finance apartments, hotels, shopping centers, and other developments into the securities and sells slices with varying levels of risk and return. The practice helps banks move loans off their balance sheets and frees up capital to fund new projects.

The market is coming off a high point. Some $101 billion in CMBS were issued last year, the most since 2007, according to industry newsletter Commercial Mortgage Alert. Analysts who had earlier projected issuance to expand by up to 25% this year now are revising down their forecasts.


The concern is that weakness in the financing market could hurt property values, which the Federal Reserve has warned were getting frothy.

Commercial-real-estate values are generally based on the income the properties generate and buyers’ borrowing costs. If investors and lenders pull back significantly, borrowers would have to put up more cash or equity, which could hurt property values, Trepp mortgage analyst Joe McBride said.

A national commercial-property price index from Moody’s Investors Service and RCA rose 12.7% in 2015 to an all-time high and is now 17.3% above its precrisis peak. Price gains slowed in the second half of last year, however.

Already there are signs that lending standards are loosening as borrowers try to keep up with rising values. Loan-to-value ratios have been creeping higher, and more borrowers are taking out interest-only loans.

“While loan underwriting has gotten more aggressive as the cycle has progressed, we do not see the type of extreme leverage levels in commercial real estate that we saw in the years leading up to 2008,” said Jim Higgins, managing member of Sorin Capital Management, an investment firm.

My view here is that, for now, is that the warning light flashes noted in the piece are confined to the capital markets and are not impacting the underlying “physical space” market.

This article was written back in mid February. CMBS pricing was being affected by the general high level of volatility in global markets. This volatility has since abated somewhat.

Now, if for an extended period real estate debt pricing were to remain higher than we’ve experienced in recent years, eventually there will be an impact on market fundamentals. This year and next, large amounts of debt will be coming due from the ’06-’07 “boom” period. This is debt that the market has been confidently assuming will be refinanced easily due to low interest rates.

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