CMBS Issues Power Through Despite Rising Delinquencies 

The commercial mortgage-backed securities lending market is having a great year. According to the Commercial Real Estate Finance Council, private-label CMBS issuance totaled more than $83 billion for the first nine months of the year—nearly double last year’s total volume of $46 billion. 

The CMBS market, however, is a tale of contrasting fundamentals, as delinquencies and special servicing rates for existing loans (5.7 percent and 8.8 percent in September) continue to climb. But despite those rumblings, experts say CMBS remains a reliable avenue for borrowers looking to capitalize stable, cash-flow-positive commercial properties and portfolios, albeit at terms that may be less appealing than in the past. For some, it may even be the only way to get financing these days.

The current advantages

One of the most appealing elements of CMBS today is its ability to navigate market challenges such as interest rates, cap rates and treasury yields.

In response to nearly 16 months of rate hikes, for example, underwriters offered five-year fixed-rate terms instead of the traditional 10-year. “While it’s a higher rate that you may not love, you are only locking it in for five years, which allows you to refinance out after that period,” Trepp Chief Product Officer Lonnie Hendry told Commercial Property Executive.

Borrowers also find the structure more flexible and responsive to market conditions in ways that portfolio lenders aren’t, according to Kevin Swartz, executive director of Tri-State equity & finance at Avison Young. 

Borrowers with stabilized, cash-flow-positive benefit from the loans’ nonrecourse underwriting, all while getting higher proceeds than banks and other lenders would offer. For some, however, it may be the only option.

Underwriters, meanwhile, are feeling more comfortable about market conditions. “The leading factor of this origination boom is that the markets realize that the Federal Reserve was not going to raise rates in 2024 unless something outside the norm happened, and that stability increased the availability of capital,” said Hendry.

The changes in the 10-year treasury yield this year have been “dramatic,” coming down to 3.75 percent since the year’s high of 4.7 percent back in April, noted Walker & Dunlop Executive Vice President Susan Mello. But the context is important, given 2023’s sharp increases in bond yields.

Inside the bonds

The majority of deals securitized this year—nearly two-thirds—have been single-asset, single-borrower transactions. According to CREFC, $50.6 billion of SASB had been issued by Oct. 4, while conduit issuance was about $24 billion and CLO issuance was $7.6 billion.  

Generally, these are larger portfolio deals for well-capitalized, well-located assets that are out of other capital providers’ price ranges, according to James Millon, U.S. president of debt and structured finance at CBRE. 

In October, a joint venture of Tishman Speyer and Henry Crown & Co. obtained $3.5 billion in proceeds to refinance Rockefeller Center in the largest-ever CMBS transaction for a single office asset. The five-year loan carried a fixed interest rate of 6.23 percent.

Office SASBs dominated the market last year, but this year, large single-asset deals are being done across all property types. In September, LBA Logistics secured $578 million in CMBS financing for a 25-property portfolio of industrial buildings that spans 10 states.

“We have a lot of data centers, industrial portfolios and multifamily portfolios this year and very few last year,” Millon detailed. “You’ve seen retail, hospitality, net lease—just about every asset class coming through the system as it relates to SASB.”

Given where interest rates lie, it’s often not a matter of choice for many borrowers with large loan requirements. “In the past, they have been able to (go) through syndications, but right now CMBS has been absolutely vital to keeping that market open and keeping those loans,” Swartz said.

The higher proceeds of the SASB loan gives borrowers a bit more autonomy, particularly in financing strongly performing industrial properties. “All lenders want good industrial,” she said. “It then becomes a matter of: What does the borrower want in terms of proceeds and (bid-ask) spreads?”

In the conduit market, there are pockets of opportunity. Barry Gersten, managing director of Capital Markets at Northmarq, sees retail, particularly unanchored neighborhood shopping centers, as well as older Class B and C industrial properties with strong occupancy as good candidates for CMBS. “(They’re) potentially very well-performing properties with local tenants that may very well have been there for a long time,” Gersten said. “They’re just going to be less appealing to certain institutional and portfolio lenders.”

Highest highs and lowest lows

Meanwhile, the delinquency and special servicing rates for existing CMBS issues continue to trend slowly but surely upward.  

Office properties have far and away the highest rate, at 8 percent, retail sits at 6.2 percent and industrial is at the bottom at just of 0.5 percent of loans becoming delinquent. This year alone, more than $602 billion in commercial mortgage loans are coming due.

But existing bonds are still by and large performing well. “The sky-is-falling narrative is a little bit of hyperbole relative to what the actual data says,” Hendry added.

Still, Hendry sees the Fed’s interest rate cuts as a net negative for investors whose initial 3.5 to 5 percent interest rates taken out several years ago may now be in the 7 to 9 percent range. “It means that your value is going to take a haircut on the appraisal, it means that you are going to have to come to the table with more capital upfront to refinance, and you may have to do a cash-in refinance as opposed to a cash-out one,” he detailed.

Special servicing also appears to be mostly an interest rate problem. “That borrower is going to have the same rate as anyone who’s in the market today with the maturing loan; they may not be able to get the proceeds that they need,” Swartz explained.

But the performance of existing bonds is context-dependent—it’s market by market and building by building. “You could have two buildings on the same street with significantly different outcomes, depending on how they are managed, the debt load they have and the tenant mix they have,” said Hendry.

For instance, a Class A office property in Portland, Ore., may be a lot worse off than one in Miami, which has recovered roughly 90 percent of its foot traffic since 2019, according to data from Placer.ai.

Forward-looking prescriptions

With the Fed broadly anticipating that its benchmark rate will fall to 4.4 percent before the end of the year, both the benefits and risks of CMBS are likely to be magnified. Lower interest rates mean more stability, which could change the nature of the lending terms, according to Mello. “You are going to see more fixed-rate, longer-term debt being put on,” she said.

Millon also anticipates rate cuts spurring more floating-rate originations. “With the Fed cutting rates, the short end of the curve is coming down,” he said. “The funds rate will come down, SOFR will come down, and that will allow people to tap more floating-rate executions.”

Read the November 2024 issue of CPE.