Cash Flow More Volatile but Still Stable: Fitch CMBS Study

Led by the retail and multi-family sectors, a measure of CMBS investment risk has edged upward for the first time in four years, a study by Fitch Ratings has concluded. The analysis of five major property sectors in 379 markets shows that the average cash-flow volatility of properties nationwide score reached 2.98 in 2007, a slight increase from the 2.94 score tallied in 2008. The 306 secondary markets studied showed more volatility than did the 73 primary markets. According to Fitch, the results jibe with expectations generated by a slowing economy. “I think you’re starting to see the effect of new construction and new deliveries on the retail front,” said Robert Vrchota, a Fitch managing director and lead author of the study. As for multifamily, an excess of condominium units being placed on the market helps explain the increasing volatility of multifamily cash flow—up to 3.12 from 3.04 last year. The sector’s volatility score rose from 2.24 two years ago to 2.50 in 2007, reversing a three-year trend of improvement. However, an equally striking finding of the new report is the increased stability of the scores. Across property types and geographic locations, 82 percent of the scores nationwide stayed the same year-over-year. Last year, only 75 percent of the volatility scores were unchanged, indicating a slightly greater degree of stability in cash flow across the board. Compared to the report released a year ago, which is based on historic data through 2006, a smaller number of scores showed improvement: only 8 percent, as opposed to 22 percent last year. Ten percent are more volatile this time around, up from 2 percent in the 2007 report. The scores are one of the tools Fitch uses to gauge investment risk of CMBS asset pools. The ratings agency based its scores on data provided by Property & Portfolio Research Inc., an independent econometrics research company. Generally speaking, a higher volatility score means more volatile net operating income—and, therefore, the riskier an asset class in a given market. Using a complex formula, Fitch bases two-thirds of the scores on the 10-year rolling history in a market. Technically, that portion of the score reflects the standard deviation of quarterly net operating income growth for each metropolitan statistical area. The other third of each score comes from a ten-year forecast for cash flow of a property type in a specific market. Those forecasts sometimes add a twist to the scores, because an volatile market with high projected growth may ultimately outperform a more stable market.