Growth Market

Clay Sublett stays nimble but predicts greater CMBS role.

Clay Sublett Stays Nimble but Predicts Greater CMBS Role


CPE editorial director Suzann D. Silverman spoke with Clay Sublett, senior vice president of Key Bank Real Estate Capital, about the CMBS market.

Q. How do you find the permanent financing market shaping up for this year relative to last year?

A. There’s been improvement in the market, both in terms of the market fundamentals and the availability of capital across all the products. Specifically, on the CMBS front, we’re already at last year’s numbers. Clearly, we will produce more loans, there’s more financing going on, there are more properties trading hands. And so while the basic economics of commercial real estate have improved, it still has its challenges, but in general it will be better than last year.
Q. How do you see the role of CMBS in the market now relative to last year?

A. Last year’s origination volume as an industry was $48 billion, up from $30 (billion) the year before. This year, we’re looking at something in the neighborhood of $45 billion already this year. The projections at the beginning of the year, depending upon who you talk to, were as much as $100 billion. We were certainly on track to do that, and then the recent volatility, both in terms of what we refer to as credit spreads but also Treasuries and swap rates bouncing up, has created some disruption in the flow. It will knock down the numbers for the year. S&P says $65 billion. If I were to pick a number for the industry, I would say probably something in the $75 billion (range). We’re all rebuilding pipelines, we’re all revisiting and adjusting—lenders and borrowers—where the coupons are right now. …
CMBS is growing. Life companies are very, very excited. Certainly, the disruption in the market recently plays to the benefit of the general account lenders—the life companies, the banks, things of that nature—because they don’t experience the volatility and the swings and the uncertainty that we have with the CMBS industry at this time.

Q. What are the limitations on what’s able to be financed in the CMBS market?

A. We have seen more of what I call middle-market borrowers coming to CMBS. Back in 2011 and really into 2012, most of the borrowers were institutional REITs, funds. … The biggest impediment is, as I said earlier, the uncertainty. We don’t lock rate early, we don’t fix the coupon until closing. And so what borrowers have experienced over the last 60 days (as of mid-July) is the market risk aspect of CMBS, and that causes angst. That causes deals to fall out. … The volatility is the biggest impediment. CMBS is able to take on a lot of shapes and sizes and property types and things of that nature, and that’s where a lot of the value is with CMBS.

Q. Can you talk more specifically about your own strategy and how you have changed it or may change it as the market continues to shift?

A. Key’s approach is to have as broad of a spectrum of products as we can to meet our borrowers’ needs. So we’re a Fannie Mae DUS, Freddie Mac Program Plus, FHA, CMBS, life company—what we call “investor placement.” Obviously, we have balance sheet, we have floating rate, shorter term. The idea is, if you’ve got a broad enough array of products, you can, one, serve your client, and two, adjust to what the market throws at you.
Back in 2006-2007, so many shops were dominated by CMBS, and when CMBS went away, it left a huge hole in the market. We were able to pivot a lot of our people to focus on Fannie and Freddie. The big issue in the industry over the next few years is what’s going to happen to Fannie and Freddie. Nobody knows the timing; nobody knows what’s going to happen. There’s a lot of uncertainty. But here we say, “We’ll roll with it. We’ll deal with it. We’ll pivot once again.” We’ve been doing a lot more life company deals. We’re continuing to grow CMBS. It is challenging because of the fact that … it used to be, you looked at a transaction and you said, “Oh, that’s easy—that’s a Fannie or a Freddie, and we have both of them.” Now you look at a transaction and you say, “Oh, boy, it may be Fannie, it may be Freddie, it may be life company, it may be CMBS.” So we find ourselves working a lot harder with various executions to serve the client’s needs. But that’s just the reality of the marketplace.

Q. Is there something that can be done to establish greater stability?

A. I don’t know that there’s anything that the CMBS industry can do. I mean, these are certainly macroeconomic issues. (Federal Reserve chairman) Ben Bernanke hiccups and the market reacts. And in some ways interest rates moving up is not a surprise. Some might argue that it’s a good thing because rates have been kept artificially too low. It’s the movement from Point A to Point B that makes it so painful. … The financial markets are very, very resilient and they find a way to transact, but it’s the uncertainty and the volatility that makes everyone sort of move to the sidelines.

Q. When the recession began, there was a lot of concern about the loss of CMBS—it was said to be vital to the health of the real estate investment market. How important do you consider it to be today?

A. I think it’s very important because, as I said earlier, it is a product that covers a broad spectrum of property types, property sizes, property quality. It’s a very important product to the market in general. One of the problems that we had in the last cycle is that it got too big. I mean, domestic CMBS origination in 2007 was $230 billion. It was just way too big. It’s certainly relevant now. We talk in CMBS circles about what’s an optimum size? Probably at least $50 billion, and I think if it starts getting north of $100 billion it may be too aggressive. But I think it’s a very significant portion of the market. If it ends up the year at $75 billion, that’s probably going to be more than life insurance companies combined, that’s going to be more than Fannie/Freddie combined. It certainly is a significant piece of the market. And I think it continues to fill a very important position in the market.

Q. What are your expectations for the permanent financing market and especially for CMBS for next year?

A. We think that we will continue to grow CMBS. Last year for CMBS, we originated a little north of $500 million. Our target for 2013: We would like to be approaching $1 billion. And I’d say for 2014, I think we will continue that growth trajectory and would like to see something roughly in the neighborhood of $1.5 billion. Now, we’re also very active in terms of Fannie/Freddie. Last year, we did well over $1 billion in each of those products, and we’re on track to do that (this year), as well. If Fannie/Freddie started contracting, which is certainly what the thought is, we will see more business gravitate over to CMBS. We look a lot at the balance across our products in the mortgage group, and we want to make sure that if it gravitates away from one execution, that it gravitates to an execution that we have as opposed to it leaking out somewhere else.

Q. What are your biggest concerns about the CMBS market? Anything besides volatility?

A. Volatility is the biggie, and that dovetails with inability to effectively hedge. I would say the other concern is, there’s always a balancing act in terms of credit and in terms of discipline. What I mean by that is that it’s an industry that has a propensity to get carried away. It gets overheated. There’s a herd mentality. If somebody gets away with lower debt service coverage, higher (loan-to-value ratios), everybody says, “Boom, I’ve got to go there—I’ve got to gravitate to the lowest common denominator.” That’s a concern—that people get reckless and forget the lessons of the downturn. Because a healthy industry requires a degree of discipline, and reasonable returns are good; gross profit tends to lead to more competition; more competition leads to a lack of discipline.

Q. What else needs to be done to improve or further expand the CMBS market? What else can banks do to help it grow?

A. Hedging continues to be a big issue. Stability in the marketplace is a biggie, but the banks don’t have any control over that. It’s sort of what the market dictates. And then it kind of begs the question of, OK, how much do you need it to grow? What’s the optimal size for CMBS? And as I said earlier, if it gets too big then it starts to dominate. I personally believe that a balance across various financing alternatives is a good thing. Borrowers comparing alternatives, whether that’s shorter-term, longer-term, fixed-rate, floating, Fannie/Freddie, CMBS, life company—the balance within the market is a good thing. But I don’t know that there’s anything necessarily that banks can do except to be as transparent as possible and to be as efficient as possible.

Q. Do you see real estate investors having unmet needs that the financial market could fulfill?

A. I would say probably the most underserved market right now is small commercial loans. I have borrowers and brokers that call and say, “I’m looking to refinance this $900,000 loan.” There are very, very few players for small commercial loans. Now, does that mean that we’re going to start a small commercial loan program? Not necessarily. It’s also an area where there’s been very high delinquency, very high defaults, a lot of stress. Those tend to be thinly capitalized borrowers, oftentimes tertiary markets. But the availability of funds for less than $3 million commercial loans is pretty limited. I generally advise people to go talk to their local bank. And they say, “Yeah, but I really want fixed rate.” … There were small loan programs before. There are some people talking about that. But that’s certainly an underserved segment.

Read this article in its original format in the September 2013 issue of CPE