At the 2013 Mortgage Bankers Association CREF/Multifamily Housing Conference, David Durning, president and CEO of Prudential Mortgage Capital Co., explains Prudential’s targets for balance sheet, Fannie Mae, Freddie Mac and FHA, CMBS and bridge financing for 2013.

L to R: Randall Row (moderator); David Neithercut, Equity Residential president & CEO; Debra Cafaro, Ventas Inc. chairman & CEO; Mchael Fascitelli, Vornado Realty Trust former president & CEO; Roy March, Eastdil Secured CEO

Speaking at the DLA Piper 11^th Global Real Estate Summit in Chicago yesterday, industry movers and shakers remained only cautiously optimistic about the future of commercial real estate, despite several indicators pointing to a rebirth of the field.

“U.S. commercial real estate markets are viewed as stable havens; real estate cap rates will also remain steady,” said Jay Epstien, DLA Piper U.S. Real Estate Practice chair, during the introduction of the conference. “U.S. commercial real estate is on the right track, (but the) question remains, will we not repeat mistakes of the past?”

Several of the panelists speaking at the summit, which one speaker called the “Woodstock of commercial real estate professionals,” commented on the return of commercial mortgage-backed securities showing that commercial real estate lending is back and reflecting good times for borrowers. Even though the CMBS market is nowhere near the $230 billion in sales registered in 2007, it reflects a steady recovery, with $7 billion available in the fourth quarter of 2012. Roy March, CEO of Eastdil Secured, said more than $85 billion is expected, with $30 billion already issued to date, “and this is the bottom line of where loan pricing is today,” he said.

CMBS is seen as a necessity by some. At its prime in 2007, it backed 40 percent of all commercial real estate lending. Nevertheless, some attendees expressed a fear of the return of CMBS, reflecting on the mid-2007 national subprime crisis and subsequent credit squeeze, which shut down the main lending arena for property investment CMBS – sending commercial property prices into a downward tailspin. Still, more loan availability makes CMBS an attractive investment as long as lenders take a serious look at the new rating agency and are willing to do proper due diligence prior to handing over money.

Overall, the real estate debt market is characterized by significant CMBS demand for conduit and single-asset executions, strong demand for life company and bank financing, continuing demand for longer durations (15 to 20 years and more), increasing prepayment flexibility, growing availability of debt for transitional assets, and significant spread tightening.

The current theme in the equity capital markets, according to an Eastdil study March presented during his panel, shows that the market in general continues to be very active and liquid. Cap rates are stable to falling. Pricing has recovered to 2006 levels or higher for most institutional assets. Unique assets continue to draw capital from around the globe. And pricing doesn’t yet fully reflect the strength of the debt markets. The market continues to achieve cash flow, quality and security needs, but it is putting a reasonable spread between trophy and other Class A assets. While there is still a material spread between primary and tertiary markets and assets, the CMBS market is expected to narrow that gap.

Another recurring theme was the strengthening of REITs relative to the private players. REIT balance sheets are the strongest they have ever been, and their cost of capital is at an all-time low. Massive dedicated and non-dedicated inflows and expansion of ETFs are driving markets. And equity issuance volumes have been high, with $130 billion raised since 2009-2010.

“I believe 2013 will also be a record year for equity issuance, at least in the current cycle,” March added.

In addition, IPOs have been successful, especially in off-the-run property types. Merger-and-acquisition activity is likewise expected to grow this year.

In conclusion, debt markets are strong, while CMBS is setting the pace. Public markets continue to increase. CMBS players are financing deals in major markets first but likely to expand into the rest of the top 30 markets, which will create some compression and relative returns. Property pricing does not yet fully reflect strength of the debt markets, particularly pricing in the non-gateway cities. Economically sensitive pricing is improving, according to Eastdil data, but there are still opportunities in “manufacturing to core.” Activity should continue to increase, with 2006/2007 debt maturities that have been extended coming due in 2013/2014. The study did caution against complacency, given how fast rates can change due to continued European challenges, the Middle East turmoil and job growth issues.

“The country is growing—not as fast as we’d like, but we’re better off than other parts of the world,” said David LaRue, president & CEO of Forest City Enterprises, speaking about the risks and rewards of real estate and the public markets. “The U.S. is a great innovator. Uncertainty is holding us back, (but) that will clear eventually.”

Could the conduit financing recovery reverse course overnight? Not likely, according to some experts, who believe a sudden evaporation of conduit financing is less likely this time around because the economic recovery appears to have legs.

Make no mistake, spreads for conduit loans can spike, as has been demonstrated in recent history. “We have seen disruptions before. There were a few instances in the last years. Spreads can increase suddenly, and CMBS financing can become non-competitive very quickly,” said Gary Tenzer of George Smith Partners.

A recent false start in the CMBS market occurred in 2011, when the recovering market was derailed by the European debt crisis and concerns about the U.S. economic recovery. “Because of the volatility, it was difficult to price deals on the front end,” explained Rusty Fleming, partner at Morris, Manning and Martin L.L.P. When the loans were taken to market, the conduits were not able to obtain the yields they anticipated. “That shut down the market.”

However, though a reversal of the current CMBS financing recovery is “always possible,” it is currently unlikely, according to Fleming. “We feel the U.S. and world economy are at different places now compared to two years ago.”

Tom Muller, co-chair of the real estate and land use practice group at Manatt, Phelps & Phillips L.L.P., agreed that the conduit market “would not be as easily derailed again.” He elaborated: “We expect the conduit market will be sustained for the next several years because the U.S. general economic recovery will be sustained for the next several years.”

Tenzer said borrowers can protect themselves against possible CMBS market disruption by locking in rates. “CMBS is a volatile market. Until you get to the point of locking the rate, you do not know you have a deal.”

CMBS financing allows for early rate locks of about 30 days in advance. But Tenzer also stressed that the borrower should not lock the rate until the due diligence, such as environmental reports, has been performed. Borrowers could lose their deposit if they lock the rate and decide not to complete the transaction.

 For more on the conduit market’s performance, see “Comeback Redux” in the May 2013 issue of CPE.

San Diego—Mortgage originations for commercial properties will increase by 11 percent in 2013, the Mortgage Bankers Association (MBA) forecasted. The market share of multifamily financing may tick down this year as capital supply to the other commercial real estate sectors make a comeback.

At MBA’s Commercial Real Estate Finance/Multifamily Housing Convention & Expo, MBA released its 2013 mortgage financing outlook. Originations of commercial and multifamily mortgages will grow to $254 billion in 2013, compared to $229 billion in 2012. (In its inaugural financing volume forecast, MBA had predicted the 2012 volume to be $230 billion.)

“Our forecast anticipates Fannie Mae, Freddie Mac and FHA, as well as life insurance companies, will all continue to have strong appetites for making loans, and—coupled with growth in originations for CMBS—the total market will continue to expand,” stated Jamie Woodwell, MBA’s vice president of Commercial Real Estate Research, in a press release.

At a press briefing during the conference, Woodwell predicted that multifamily financing will total about $105 billion in 2012. This financing volume far outstripped expectation, as only $77 billion was originally forecasted for the multifamily sector for the year.

Multifamily financing volume may experience a slight shrinking in 2013 and subsequent years to “a more traditional size” relative to the overall commercial property mortgage market, said Woodwell, during a press briefing held at the conference. Woodwell said multifamily financing had seen its share of the overall commercial property financing market increase due to funding availability and multifamily fundamentals. In 2012, multifamily financing was 46 percent of total commercial property mortgage financing. As mortgage funding for the other sectors are returning a little more strongly, however, “we’ll see more of that traditional balance” between the multifamily and commercial property market shares, said Woodwell.

MBA forecasts GDP to increase to 2.0 in 2013 from 1.8 percent last year, while unemployment rate will fall to 7.6 percent, compared to 8.1 percent for 2012. MBA said the 10-year Treasury yield will rise slightly from 1.8 percent in 2012 to 2.2 percent for 2013. However, actions by the Fed, on which a large part of the interest rate prediction is predicated, could be unpredictable, noted Jay Brinkmann, chief economist and senior vice president of Research and Education.

In the fourth quarter of 2012, MBA reported that commercial and multifamily mortgage originations increased by 49 percent compared to the fourth quarter of 2012. “During the fourth quarter, commercial and multifamily mortgage borrowing and lending hit the highest level since 2007,” stated Woodwell. MBA’s mortgage bankers originations index shows originations for 2012 increased by 24 percent compared to 2011.

The fourth quarter increase in commercial/multifamily lending volume was driven by increases in originations for hotel and office properties, according to MBA. The mortgage financing volume increases, relative to fourth quarter 2011, were 331 percent for hotel properties, 78 percent for office properties, 49 percent for multifamily properties, 46 percent for industrial properties, 5 percent for retail properties and 26 percent for health care properties.

By investor type, the dollar volume of loans in the fourth quarter compared to the same period in 2011 rose by 228 percent for CMBS, 68 percent for commercial bank portfolio loans, 51 percent for GSEs and 18 percent for life insurance companies.

MBA President & CEO David Stevens

The low-interest-rate environment is driving the demand for relatively higher-yielding commercial real estate loans, and the commercial real estate financing industry cautiously greeted the rapid return of liquidity into the sector during the Mortgage Bankers Association’s (MBA) 2013 Commercial Real Estate Finance/Multifamily Housing Convention & Expo. The exposition opened on Monday with a record attendance level of about 2,600.

“As the year begins, we can see positive momentum,” said Debra W. Still, 2013 MBA chairman, at the opening session. “Commercial and multi-family real estate finance has enjoyed a relative calm amidst the storm.” Still, she noted favorable conditions for both financing and commercial real estate–interest rates are lower than ever before, and yields and cap rates remain attractive relative to those of other investments. “Multi-family markets have arguably never been stronger, and office and retail markets offer plenty of upside.” Still cited, however, challenges to the commercial property sector including the European sovereign crisis and federal deficit, and she referred to the current “artificially low” interest rates.

“You feel good about the business environment, and you should,” said David Stevens, MBA president and CEO, in addressing attendees during the opening session. Stevens said that delinquencies are at the lowest level since 2009, the $2.4 trillion in mortgage outstanding is increasing, and CMBS issuance is expected to grow this year to $65 billion from $45 billion last year. “This really reflects the demand and recovery on the private capital side.” Life insurance companies and banks, meanwhile, are also looking to retain mortgages, he said.

On the other hand, although the low interest rates provide many benefits, Stevens said, capital is struggling to obtain concurrently desirable yield levels and asset quality in the low-yield environment.

One fear among market participants is that debt investors’ bid for the relatively higher returns offered by commercial property could lead to lower underwriting standards and a weakened CMBS sector—all too soon–as lenders compete for the same deals.

Debt investor groups across the board are generally said to be increasing their appetites for commercial loans this year. CMBS and bank financing has returned to the market, while life insurance companies and the GSEs are expected by many industry players to maintain if not increase the dollar amounts of their financings in 2013. Fannie Mae closed 2012 with $33.8 billion in multi-family financings, while Freddie Mac announced $28.8 billion in new multi-family volume for the same year.

A key driver of increased liquidity for the overall commercial property sector has been the recovery in demand among investors for CMBS. “Sustained bond market rally in the second half of 2012 has helped drive down funding costs, enabling CMBS lenders to reduce rates charged to borrowers,” stated Jones Lang LaSalle in a press release.

In the session “The Search for Yield,” moderator E.J. Burke, executive vice president and group head of KeyBank Real Estate Capital, commented that it appears “there is far more capital chasing for a home than there are good deals.”

“A lot of this has come back too quickly. We are concerned about how fast things have moved in terms of risk tolerances,” said Kevin Riordan, president, CEO and director of CreXus Investment Group. “I can’t answer if $100 billion is a normal market [for CMBS financing], but I think we are getting there too quickly.” Riordan also said that the “creep” over time of lenders institutions to the secondary market has already turned into a “herd.”

Life companies are still under-allocated to the multi-family sector in the billions, estimated Brian Casey, managing director and head of real estate debt strategies of MetLife Inc., in responding to a question about how much financing life companies would execute under ideal circumstances.

And Diana Reid, executive vice president of PNC Real Estate, said that banks have resolved their balance sheet issues and become more competitive in multi-family construction financing in the fourth quarter. As a result “there are more lenders looking for the same deals,” she said. Still, pricing, rather than recourse, remains the point of competition.

There were also questions raised about the self-regulation of CMBS and whether B-piece buyers are holding onto the risks rather than selling them. “I do not believe we are at CMBS 2.0,” said Reid, referring to the new, safer regime of CMBS that will prevent a repeat of 2007. Reid noted the Dodd-Frank risk retention regulations are yet to be released.

MBA announced this week that it forecasts commercial multi-family mortgage originations to increase by 11 percent to $254 billion in 2013 from 2012. Commercial and multi-family mortgage originations jumped by 49 percent in the fourth quarter compared to the same quarter in 2012.

By investor type, the dollar volume of loans in the fourth quarter of 2011 compared to the same period in 2011 rose by 228 percent for CMBS, 68 percent for commercial bank portfolio loans, 51 percent for GSEs and 18 percent for life insurance companies. For the entire year, originations in 2012 rose by 24 percent, MBA reported.

JLL said it expects capital availability to drive transaction volume increases of 15 to 20 percent in 2013. “Competition for core product is opening up attractive opportunities for borrowers,” it stated, and that JLL’s capital markets experts are “seeing a variety of aggressive debt structures,” on core products such as debt yields between 8 and 10 percent and DSC ratios of 1.15 to 1.35.

While making possible many deals and rescuing mortgages from default, the extremely low interest rates also introduce another point of concern: refinancing risk in the future when and if interest rates should increase again, and many speakers referred to that risk. Financed at extremely low interest rates, properties may have difficulty finding refinancing if interest rates rise significantly in future, especially if they have not amortized, or property values do not rise, adequately.

The longer the low interest rates persist, the greater the buildup of stress, said Sally Gordon, managing director, Risk and Quantitative Analysis Group, of BlackRock, Gordon presented a general session on portfolio diversification strategy.

The seeming lack of euphoria among lenders despite the return of liquidity could also  be attributed perhaps to the recognition that the abundance of capital, especially that slushing in the CMBS markets, could disappear overnight and be affected by both foreign and domestic developments, as has happened in recent memory. “Liquidity can evaporate faster than you even thought possible,” commented Gordon.

The potential volatility of the capital markets tied in with the life lessons of guest speaker John Bucksbaum, founder of Bucksbaum Retail Properties LLC. Bucksbaum recounted his experiences with the financial crisis in the late-2000s as former CEO of retail giant General Growth Properties (GGP). One of his biggest mistakes, where the GGP bankruptcy was concerned, was to allow mortgage maturities to compress in the same time period, said Bucksbaum. The second mistake, in view of the fact that liquidity could disappear very quickly, was to not raise equity when there was the opportunity, and to wait for higher stock prices before making a stock offering for the public company. “You don’t always know when you can raise equity. The day may come when “you need equity, and you don’t have it,” said Bucksbaum.

And as Gordon said, once liquidity dries up, it may be too late to mitigate the risk.

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The U.S. CMBS market has entered into new territory. According to Trepp L.L.C.’s new report, the CMBS delinquency rate has reached an unprecedented 10.16 percent.

Taking into consideration the results from May, it’s a situation of big news followed by bigger news. After having jumped 24 basis points to 10.04 percent in May, thereby crossing the 10 percent threshold for the first time, the delinquency rate rose 12 basis points to 10.16 percent in June. All told, the CMBS market has experienced a 64-basis point increase since late 2011.

Trepp saw it coming. In December of last year, the information and analytics provider predicted that what had then been a steady rate in the 9.51 percent range could skyrocket by 70 basis points within the next several months.

“Driving the rate up has been the fact that only 28 percent of the loans from 2007 due to mature in 2012 managed to pay off in full,” Manus Clancy, senior managing director with Trepp, said. “Just as the heat should break by September, investors should see some relief, too. Now that most of the 2007 loans coming due in 2012 have passed their maturity date, the delinquency rate should start to level off soon.”

But for now, the numbers are still staggering, due in no small part to the lackluster performance of nearly every commercial real estate type. The delinquency rate for hotels did the most damage with a surge of 68 basis points to 12.95 percent; although the sector still hasn’t surpassed multifamily, which held steady in the top spot at a rate of 15.17 percent. The jumps in office and retail were relatively modest at a respective 19 and 10 basis points. However, there was one shining light in the group. The industrial sector experienced a head-turning drop of 128 basis points to an 11.54 percent delinquency rate.

And a little improvement is better than none at all. Approximately $59 billion in loans, excluding those with a special servicer, are delinquent, compared to $59.1 billion in May.

The Urban Land Institute and PricewaterhouseCoopers L.L.P. have released the results of the annual Emerging Trends in Real Estate survey — and the responses point to a stronger commercial real estate outlook for the remainder of 2012. The more than 195 participants believe that profitability, lending, and investor markets all show brighter signs and that markets are looking up for CRE firms.

The survey, which has been issued for 33 years, is jointly produced by PwC and the ULI, and it includes survey responses from more than 950 leading real estate experts, including investors, developers, property company representatives, lenders, brokers and consultants. For the mid-year survey, 195 participants who completed the original 2012 Emerging Trends survey were interviewed.

Most importantly, the survey showed a general trend toward optimism, even when compared with the year-end 2011 results. The number of respondents rating profitability forecasts for 2012 as excellent rose by approximately 2 percent, and the number rating the category as very good rose by the same amount. In fact, the only rating that fell was the abysmal-fair bucket, which dropped by approximately 10 percent.

According to the report, foreign investors and private equity will still lead the charge as active buyers of commercial real estate, but both values have declined slightly.  The biggest jump came from private local investors and public equity REITs.  According to Real Capital Analytics through the first quarter of this year, private-capital investors have completed the most deals, followed by public-equity companies.

The sources of debt capital values displayed some positive signs in the mid-year update.  Insurance companies continue to be number one overall.  However, government-sponsored entities’ value increased over 11 percent from the original survey in November 2011.  Other strong gains were found in the CMBS market, commercial banks, and mezzanine lenders all strong signs that the availability of debt is showing improvement.  According to Commercial Mortgage Alert, U.S. CMBS deals total $10.8 billion, up over 12 percent year-over-year.  In addition, RCA states that there were increases in lending as well in completed transactions.

Sentiment at ULI’s spring conference in Charlotte, N.C., in early May reflected the same results as the survey. During one of the sessions, Glenn Grimaldi, executive vice president at HSBC, cited low interest rates as a major trend that is driving the real estate industry by allowing for low acquisition cap rates. The low interest rates will also have implications on the amount of deleveraging as loans mature in the next few years, he said. Grimaldi forecasted that banks may sell more loans at discount in the next years.