The commercial mortgage-backed securities market is expected to grow between $150 billion and $200 billion in the next three years, buoyed by pre-crisis CMBS coming due that will need to be refinanced or restructured.
After roughly three years of near zero issuances following the financial crisis, the CMBS market is slowly starting to ramp up. CMBS debt increased 9.2% to $94 billion in 2014 from $86.1 billion the year before, according to the most recent data from Trepp LLC, a New York-based real estate research firm.
The fate of the CMBS market is important to real estate investors because those securities are one way to finance commercial real estate. CMBS contributed about 20% to the volume of real estate lending in 2014, just behind the 35% from banks, said Mark Rasimas, executive director and senior portfolio manager in the New York office of money manager J.P. Morgan Asset Management, quoting the most recent Mortgage Bankers Association statistics.
The industry consensus is that CMBS volume will continue to increase, but only for a short while. The CMBS market is expected to pull back in 2018, once the massive amount of securities originating in the three years before the financial crisis is restructured or refinanced.
Some industry executives contend the boom years of 2005-"07 — when issuance was at about $300 million — were an anomaly, and that the CMBS market should normally be between $50 billion and $75 billion.
Richard Flohr, managing director, who heads the CMBS conduit program for Prudential Mortgage Capital Co., a commercial mortgage finance business, said the booming CMBS market of the last decade “creates the impression that what we have now is less than what it should be.”
“Last year's market was $92 billion, and this year it is expected to be $120 billion. That's pretty good, relative to the normalized period. It should be above $75 billion for a good period of time,” he said.
During the boom years, underwriting was inflated because lenders projected large rent increases on properties, J.P. Morgan's Mr. Rasimas said. But after the crash, many investors — insurance companies, money managers and asset owners including pension funds — had “a very ugly, expensive experience investing in structured products,” he said.
It's taken this long to “clean up the mess” and get investors comfortable again with investing in the securities, Mr. Rasimas said.
That the CMBS market is lower than its historic highs could mean that commercial real estate prices still have room to grow, said one industry executive who declined to be identified.
Some managers interviewed agree that the growth in CMBS over the next few years will support appreciation of real estate prices. But even as the picture for the CMBS market is brightening, storm clouds are forming on the horizon. Commercial mortgage underwriting standards are getting looser due to stiff competition to provide debt, JPMAM's Mr. Rasimas said.
In April, credit rating agency Moody's Investor Service, New York, warned in a report that the credit quality of loans in CMBS pools and the pipeline of securities still to be rated show “signs of further credit-quality slippage and (indicate) a high likelihood” that the leverage on the loans would soon top its pre-crisis peak.
Trepp's first-quarter CMBS issuance update, released April 30, echoed the alarm, pointing to an increase in interest-only loans — which are generally considered to be riskier than loans in which borrowers also pay down principal during the loan term.
The proportion of full-term interest-only loans has been steadily increasing over the last five quarters to 57.6% of the securitized loans in the first quarter from 52.9% in the fourth quarter and 37.3% a year earlier, the report noted. n
