On more than one occasion over the past few months, we have tried to draw readers’ attention to the potential for deterioration in underwriting discipline. We’ve highlighted comments by the Federal Reserve and the financial market regulators and the rating agencies; we have even reprinted the warning of one of our readers who is a senior officer at a commercial bank.
The following comment is from the April 2, 2014, Standard & Poor’s Ratings Services Structured Finance Research Update:
“Loan metrics continue to deteriorate. Average rating agency stressed LTVs (loan-to-value ratios) were over 104% in Q1 (2014) deals, up from 100% last quarter and 98% a year earlier. The percentage of IO (interest only) loans increased to 55%, up from 54% in Q4 (2013) and 49% in Q1 (2013). Average issuer DSCR (debt service coverage ratio) fell to 1.63 times from 1.69 times in Q4 (2013) and 1.94 times in Q1 (2013). 37 firms were either originating CMBS loans or in planning stages, according to Commercial Mortgage Alert.”
First-Quarter Numbers
Real estate investment trusts (REITs) are off to a strong start in 2014, showing returns far in excess of alternative public equity investments. REITs continue to have access to both equity and debt capital in size and at low cost, fueling their ability to selectively acquire property on an accretive basis.
| Index | |
| Morgan Stanley U.S. REIT Index | +8.52% |
| Dow Jones Industrial Average | –0.72% |
| Standard & Poor’s 500 Stock Index | +1.81% |
| NASD Composite Index | +0.54% |
| Russell 2000 | +1.12% |
U.S. commercial mortgage–backed securities (CMBS) issuance is running slightly behind schedule, but is on pace to reach $100 billion in 2014. There are any number of deals “in the works” and the industry has the financial capability to build inventory for future issuance quickly.
Year-to-Date Global CMBS Issuance (in $ Millions) as of March 31, 2014 | ||
2014 | 2013 | |
| U.S. | $20,369.3 | $22,860.0 |
| Non-U.S. | $545.5 | $2,482.6 |
| Global Total | $20,914.8 | $25,342.6 |
| Source: Commercial Mortgage Alert | ||
According to data from Real Capital Analytics, sales of commercial real estate totaled $355.4 billion in 2013. Through February 2014, sales were $46.6 billion, comprising $26.8 billion in January and $19.8 billion in February. With $100 billion in “dry powder” available to private real estate funds plus the capital available to domestic institutional investors and REITs, it seems likely that last year’s results will easily be eclipsed.
Commercial banks and insurance companies are actively pursuing deals and issuing commitments. Absent an economic or geopolitical event, both are expected to fully “invest” their allocations for 2014.
Monday’s Numbers
The Trepp survey for the period ending March 28, 2014, showed spreads basically unchanged; the implied ten-year rate for properties with 50 percent to 59 percent loan-to-value ratios is an astounding 4.1 percent.
Asking Spreads over U.S. Ten-Year Treasury Bonds in Basis Points | |||||||
12/31/09 | 12/31/10 | 12/31/11 | 12/31/12 | 12/31/13 | 3/28/14 | Month earlier | |
| Office | 342 | 214 | 210 | 210 | 162 | 154 | 144 |
| Retail | 326 | 207 | 207 | 192 | 160 | 142 | 143 |
| Multifamily | 318 | 188 | 202 | 182 | 157 | 137 | 137 |
| Industrial | 333 | 201 | 205 | 191 | 159 | 141 | 139 |
| Average spread | 330 | 203 | 205 | 194 | 160 | 144 | 141 |
| 10-year Treasury | 3.83% | 3.29% | 0.88% | 1.64% | 3.04% | 2.66% | 2.73% |
The Cushman & Wakefield (C&W) Equity, Debt, and Structured Finance Group’s monthly Capital Markets Update of commercial real estate mortgage spreads, dated April 3, 2014, showed spreads for Class A property coming in 5 to 10 basis points with spreads for Class B property coming in as much as 15 basis points as the market at all levels becomes increasingly competitive with lenders aggressively reducing spreads to win business. For now, advantage to the borrower.
In its comment accompanying the survey, C&W noted the following:
- It was recently reported that private real estate funds have more than $100 billion of “dry powder” focused on acquisitions of property located in North America. Assuming 50 percent leverage, that’s “buying power” equal to $200 billion, or 56 percent of 2013’s estimated total real estate sales transactions.
- Spreads for newly issued commercial mortgage–backed securities have remained stable to slightly tighter since January 1, 2014, with super-senior bonds trading inside 90 basis points and BBB-paper stable at swaps plus 345 to 395 basis points. What this means is spreads to borrowers continue to trend down, indicating that originators are finding it necessary to lower their profit to win business. Advantage to the borrower again.
Ten-Year Fixed-Rate Commercial Real Estate Mortgages (as of April 3, 2014) | |||
Property | Maximum loan-to-value | Class A | Class B |
| Multifamily (agency) | 75–80% | T +165 | T +170 |
| Multifamily (nonagency) | 70–75% | T +170 | T +180 |
| Anchored retail | 70–75% | T +195 | T +205 |
| Strip center | 65–70% | T +210 | T +220 |
| Distribution/warehouse | 65–70% | T +195 | T +205 |
| R&D/flex/industrial | 65–70% | T +205 | T +215 |
| Office | 65–75% | T +190 | T +200 |
| Full-service hotel | 55–65% | T +255 | T +275 |
| Debt-service-coverage ratio assumed to be greater than 1.35 to 1. | |||
Year-to-Date Public Equity Capital Markets
Dow Jones Industrial Average: –0.03%
Standard & Poor’s 500 Stock Index: +2.19%
NASD Composite Index (NASDAQ): +1.46%
Russell 2000: +1.50%
Morgan Stanley U.S. REIT Index: +9.18%
Year-to-Date Global CMBS Issuance | ||
2014 | 2013 | |
| U.S. | $20.4 | $22.9 |
| Non-U.S. | 0.5 | 2.5 |
| Total | $20.9 | $25.3 |
| Source: Commercial Mortgage Alert | ||
Year-to-Date Public U.S. Treasury Yields
U.S. Treasury Yields | |||
12/31/12 | 12/31/13 | 4/6/14 | |
| 3-month | 0.08% | 0.07% | 0.03% |
| 6-month | 0.12% | 0.10% | 0.05% |
| 2-year | 0.27% | 0.38% | 0.43% |
| 5-year | 0.76% | 1.75% | 1.71% |
| 7-year | 1.25% | 2.45% | 2.30% |
| 10-year | 1.86% | 3.04% | 2.74% |
