The CMBS Outlook: What’s Driving Deals & Debt?
- Jan 30, 2017
In the run-up to the financial crisis a decade ago, conduits issued a large volume of 10-year CMBS. Many of those loans came with 80 percent or more leverage and interest-only terms. Despite some recent fears of another CMBS crash, today’s commercial real estate market is buoyed by solid fundamentals: rising rents, climbing occupancy, historically low interest rates, strong secondary and tertiary markets, and a steady stream of capital. Together, these factors are creating plentiful liquidity.
Gabriel Silverstein, SIOR, the managing director of New York City-based SVN | Angelic and SVN’s Institutional Capital Markets chair, recently offered insights into the evolving CMBS market and its broader implications for commercial real estate finance in 2017.
CPE: What is your take on the current CMBS market?
Silverstein: Liquidity is certainly helping to drive some of the transaction activity right now, for refinancing and for investment sales, because some of those projects would not be financeable without an equity infusion, and selling becomes the best option. The sales market is generally robust and very liquid right now, with readily available, historically cheap debt, and lots of hungry equity.
CPE: Where are we in the cycle?
Silverstein: For the financing rollover cycle, right now we are in the absolute middle of the three-year, doom-and-gloom maturity wave, and to date we have seen very little negative impact, in part because the financing markets have been very good. Now that (2017 is here), already much of this coming year’s maturing debt is gone: paid, refinanced, or sold. If you can’t refinance, you can sell. Not all sellers will get 100 percent of their equity out, but it doesn’t change the fact that there is still a deal they can make for more than the debt balance in most of those sales.
CPE: What is to become of the remaining loans?
Silverstein: What’s left is not always the worst part that needs to get refinanced. In fact, it’s usually not the worst part. A lot of the good debt didn’t get refinanced early, because some of it was financed with a life insurance company, at a fixed rate, or with a CMBS loan and there is a penalty to refinance early. For borrowers still in the money and not wanting to pay those penalties to refinance before maturity, those loans will be getting refinanced now.
CPE: Despite these penalties, why haven’t we seen a considerable wave of refinancing?
Silverstein: Some borrowers did refinance early even though they were paying a big penalty. Because the market was so good, they could do it anyway (and not take the risk of rising interest rates).
But if you have a year left on a $50 million CMBS loan, you might be looking at a $2 million to $3 million prepayment penalty. A lot of borrowers didn’t want to refinance early if they could help it, because they then had to come up with that extra $2 million or $3 million in their financing, and that just gets paid out as a penalty to the current lender.
CPE: What is your expectation on foreclosure rates?
Silverstein: There are definitely a number of deals that are still going to have to work through the system that will probably turn into foreclosure deals. They haven’t yet … because the borrowers are still paying their mortgage, because there is enough cash flow to make the debt payments. But the value might not be there to sell for a price equal to or higher than the debt balance as soon as the loan comes due. Of those properties that were/are going to fail and go to foreclosure, most of the small properties with smaller owners already did that.
Unlike the earlier waves of REO deals, those still to come in the next couple years are more likely to be deals that were owned by better-capitalized owners who had money to put into their properties to keep them alive, keep them cash-flowing. While that keeps the debt paid, if they didn’t see the light at the end of the tunnel, they may not have done all the deferred maintenance … that a healthy property (needs), so the buildup of needed capital investments is often what drags the value any buyer would pay today back down below the debt balance.
CPE: What are the mechanics of these outstanding loans?
Silverstein: There are many deals where, for example, investors paid $100 million for a property using an $80 million loan and they still owe $75 million. If the building is now worth $90 million, they don’t want to sell because they would take a $10 million loss, but they are probably not going to default on the loan.
When they finally get to the end of line, they will sell, take the $90 million, pay off the loan at $75 million, keep the $15 million and lick their wounds about the $10 million loss. They would rather take the $15 million saved than lose all $20 million of equity. These are the deals we are going to see transacting for the next two years, where the investors are not going to make a profit on their equity, but they will get some of their money back.
CPE: How much of the transaction volume of the next two years will be driven by the remaining maturity wave?
Silverstein: The capital markets have been on fire, especially on the multifamily side. The fact that the debt is rolling over has something to do with it, but for the most part, it is a confluence of depressed supply growth, combined with substantial capital looking for deals. Even when the debt is not yet rolling over, people who have prepayment penalties are not sweating it because they can still cash out and put money in their pockets.
It is not so much about current debt coming to maturity that is causing an uptick in transactions. As long as supply growth doesn’t get out of control, the markets should remain reasonably healthy. Moderate growth in new supply makes renovation and repositioning of older, existing assets financially viable, and that means fewer buildings that die the financial death of obsolescence.
Gabriel Silverstein, SIOR, Gabriel Silverstein, SIOR, is the managing director of New York City-based SVN | Angelic and is SVN’s Institutional Capital Markets chair. With more than $6 billion in transaction experience, he operates in both the investment banking and investment brokerage worlds, and is a principal investor/owner, as well. All told, he has transacted $1 billion-plus in tenant representation projects, representing Fortune 1000 companies on corporate real estate transactions and portfolio management around the globe.