Mortgage Bankers Roundtable, Part I: Maturities, Here They Come: CRE Lenders Prepare to Meet the Wave of CMBS Loans Needing Refinancing This Year
By Keat Foong
Is this the year stakeholders in commercial real estate debt will have to “face the music?” In CPE’s 2012 Mortgage Bankers Roundtable, top executives of the commercial real estate financing industry’s leading companies contemplate how capital sources will meet the industry’s refinancing challenge. Participating in the roundtable are Jack Cohen, CEO of Cohen Financial; William Hughes, senior vice president & managing director of Marcus & Millichap Capital Corp.; Eduardo Padilla, president & CEO of NorthMarq Capital; and William Walker, chairman, president & CEO of Walker & Dunlop L.L.C. Part II of this discussion, “Taking Stock of Today’s Financing Conditions,” addresses interest rates, underwriting standards, CMBS and the future of Fannie and Freddie.
What is your company strategy this year?
William Walker: First of all, the refinancing volume that is coming up over the next fi ve years is a huge opportunity for a firm of Walker & Dunlop’s size and scale. Second, the difficulty CMBS has had coming back into the market provides a huge opportunity for a firm such as ours that is a non-bank financial services firm. The third is just that we are not a bank, and so much of Dodd-Frank and other regulatory issues that are challenges for depository institutions are not challenges for (us).
And (regarding) two of the big providers, CMBS, just from a structural standpoint, has not been able to come back into the market and address the opportunity very well, and banks are still, I think, trying to recover from the recession and fi gure out what the road map is for the future as it relates to their ability to finance commercial real estate.
Eduardo Padilla: We are seeing the cycle coming to a lot of refinancing opportunities, and a need for CMBS to come in to deal just with its portfolio. There will be continued consolidation of this business into a handful of large players who are able to offer an entire platform of commercial real estate mortgage banking capital—Freddie Mac, Fannie Mae, FHA, life insurance companies, banks, CMBS and some brokered activity. In addition to that, we also see opportunities to continue to grow the equity arranging part of our platform. That is an area in which we think we can excel and that we have grown significantly: arranging the equity component of commercial real estate transactions, the institutional joint venture partners, institutional-quality mezzanine financing basically, everything on the top of the capital stack other than first mortgage debt.
We think that will be a significant part of our business going forward. Hopefully, in excess of $1 billion of our business in 2012 will fall into that category.
Jack Cohen: On the servicing side of the business, we are a rated primary and special servicer, so our strategy continues to be to serve the buyers of distressed notes who need infrastructure to manage those notes. As a broker, our focus is on a balanced capital market and an equity placement practice. The borrower needs equity to replace his overleverage, and there are plenty of equity providers out there looking for deals, so as a capital markets-based service provider, we will provide debt and equity in the primary and secondary market in addition to our primary and special servicing.
Will the capital markets be able to adequately fill the financing gap that has been left by CMBS?
William Hughes: I would say for 90 percent of the CMBS deals, there is adequate financing. Capital sources come in the form of private funds, investment banks and REITs that are willing for the sake of higher yields to take greater risk in the capital stack. Whether it be mezzanine or preferred equity, there are certainly ways to structure up so that you can help recapitalize partnerships where the existing CMBS debt is upside down and you have too much debt in play one way or another. The CMBS loans may not underwrite in today’s market because vacancies have increased and rents have decreased in many markets for most property types: the retail, office and industrial sectors. So you are having to bring additional debt or equity into the deal to be able to make those deals go. I still think you are going to see some extensions in the CMBS market, as well.
Padilla: The CMBS market needs to be able to (provide financing for) its own maturing loans first. There is roughly a $600 billion CMBS market now, and that includes delinquent and special servicer loans. So if you think about a $600 billion market that is existing without even growing that marketplace, and that on average the terms of those loans are less than 10 years, then you are looking at a $60 billion to $70 billion annual need just in dealing with maturities on a straight-line basis. I say it would be healthy to see CMBS provide $50 billion in annual financing, but that will still require some of the maturing loans to be short-term extended or worked out with special servicers. Then we are talking about growing that business beyond $600 billion.
Cohen: In my view, many are missing the point. Everyone is talking about this wave of CMBS maturities that is not going to refinance. Let me disabuse you of that notion. The issue is, losses have to be taken. Let me give you a map. In 2007, $400 billion was financed in this country. Assuming on average 80 percent LTV, that means $500 billion of value traded. Everyone across the globe would accept that on average, value devalued 40 to 50 percent. That means that real estate, which was worth $500 billion, was worth only $250 billion. At the same time, you cannot get an 80 percent loan, but only a 65 percent loan. So 65 percent of $250 billion is $175 billion. Think about it: In ’06 and ’07, we should not have put on more than $175 billion of debt, yet we put on $400 billion. Of course the losses have to be taken.
Will there be a crisis?
Cohen: No. It is really simple: If you cannot pay off the loan, sell the building. Take a loss. The equity will get wiped out, the lender will have to take a loss on his loan. A new owner gets a new loan and puts new equity in, and the value of the real estate has been reset. That’s what we need to turn the industry around—not bond buyers, not more debt. We need the real estate to get readjusted to its real value. That’s what the government missed. This extend-and-pretend by the banks, delay-and-pray, special servicers extending loans because no one wants to face the music—all these have done is delay the inevitable. What people were hoping for was that the marketplace would come back—it came back, to a normal market, not to an accelerated market. The part that was abnormal was the run-up in value, not the reset that happened in 2008 and 2009.