2015 Real Estate Forecast

Improving commercial property fundamentals, a steady stream of offshore capital and an accommodating Federal Reserve interest rate policy will sustain robust property investment in 2015 as buyers keep seeking yield and safe havens in the U.S.

But rising interest rates, the cooling of energy markets amid oil's price plummet, and other variables threaten to thwart those expectations. What's more, 2015 could be the year that reveals whether escalating property prices are sustainable, especially as underwriting becomes more aggressive.

Among other trends, buyers are building more ambitious rent-growth assumptions into their underwriting to make increasingly expensive deals pencil out, says Kenneth Riggs Jr., CEO of Houston-based Real Estate Research, a national commercial property valuation and consulting firm. That's a departure from the more recent conservative practice of pegging rent growth to inflation, he adds.

Up to this point, I think value and price have been in alignment," said Riggs, whose firm was acquired in February by global commercial real estate and loan advisory Situs. "But I think we're at an inflection point and may be getting ahead of our skis. Next year we may see price outpace value."

Momentum Continues
Through November, commercial property buyers and sellers had completed nearly $366 billion in U.S. deals in 2014, topping dollar volume for the full year of 2013 by almost $5 billion, according to Real Capital Analytics, which tracks sales of more than $2.5 million.

Capitalization rates have been trending down for most major property types over the last several quarters, indicating more aggressive pricing in anticipation of continued strong investment demand and low cost of capital. The rates measure a property's initial yield for the owners, and they fall as prices rise.

The average cap rate for office and industrial buildings in November marked a year-over-year decline of 50 basis points for each property type, to 6.6% and 7.1%, respectively, Real Capital says. Apartment properties fell 50 basis points to 5.8%.

Hessam Nadji, chief strategy officer for property brokerage Marcus & Millichap (NYSE:MMI), anticipates that vacancies in 2015 will keep tightening for most property types.

Retail properties could see the most pronounced improvement, Nadji says, with average vacancy rates dropping by 60 points next year to 6% nationally in light of growing small-business confidence. In November, the National Federation of Independent Business' small-business optimism index surged 2 points over October to 98.1, a slightly higher reading than the 40-year average. Apartments, however, may see vacancies rise nationally from a current average of around 4.5% amid increased supply, Nadji adds.

From an individual-markets viewpoint, the plunging price of sweet crude oil to less than $60 a barrel from around $100 six months ago could dent investment in cities tied to the energy sector, which along with technology markets have led the nation's commercial property recovery.

Much of the focus will be on Houston, where some 17.3 million square feet of office space was under construction in the third quarter, according to brokerage CBRE Group (NYSE:CBG). In a Houston report this month, CBRE noted that a "steep fall in oil prices" would have to last a couple quarters before energy companies would alter drilling and production projects, which are planned on a long-term horizon. But it said eliminated or scaled-back projects would ultimately reduce office demand in the market.

While Houston's average office rental rate climbed 4.4% to $26.81 per square foot in the third quarter from a year earlier, the average vacancy rate ticked up 20 basis points to 14.4% over the same period, Reis says. The fall in oil prices has caught the attention of Riggs, whose firm ranks the city as one of the top-performing property markets in the country.

"Houston's economy is more diversified than it used to be," he adds, "but falling oil prices will definitely slow the momentum."

Interest Rate Question

Rising interest rates could derail property investments on a broader scale. Yet observers who expected rate increases over the past few years now say that they wouldn't be surprised if interest rates begin and end 2015 without much change.

Still, investors are aware of higher-interest-rate risks, says Gerry Trainor, executive managing director of capital markets for Houston-based property brokerage Transwestern.

"But all in all, they're moving forward because it's anybody's guess as to what happens," said Trainor, who is based in the company's Washington, D.C., office. "I don't think anybody anticipates a big, sudden rise."

The yield on the 10-year Treasury note, a benchmark for conventional commercial real estate loans, would likely have to jump more than 80 basis points to around 3% or higher before investment activity would slow materially, adds Riggs. But the yield will stay lower longer than what most people expect, he argues.

"There's a tremendous weight on keeping Treasury yields down because of global uncertainty," he said.

Nadji notes that oil's recent price decline, combined with slowing economies in Asia and Europe, prompted overseas investors to buy U.S. Treasury notes in a flight to safety that pushed the 10-year yield down some 50 basis points over the last three months.

"In addition, any substantive rise in interest rates would be accompanied by strong economic and employment growth," he added, "both of which will boost demand of commercial real estate."

Similarly, a greater cost of capital won't deter foreign real estate investors who pay with cash, notes Avi Benamu, managing partner of New York-based real estate investment manager Winchester Equities. Like offshore Treasury buyers, individuals and families in the Middle East, Russia and other areas seeing strife are buying properties in the U.S. to protect their wealth, he says.

"Even if property prices seem a little bit unreasonable they'll just park their cash in the U.S. because they know it will be safe here," Benamu said. "The money is just flowing in."

Amid the trends, CBRE and Jones Lang LaSalle (NYSE:JLL) — the two largest companies by market cap in IBD's Real Estate-Development/Operations industry group — have risen by 33% and 48% in the stock market this year, respectively.

North American Hotel Investment Conference

The 2014 North America Hotel Investment Conference (NATHIC), held November 19 through 21 in Chicago, brought together a strong showing of hotel owners, investors, brokers, consultants, franchisors, brand representatives, and students from Michigan State University, New York University, and DePaul University. Top U.S. hospitality executives served on panel discussions that addressed an array of topics related to hotel ownership, development, and management, as well as the recent proliferation of new hotel brands and the catalyzing impact of Millennials or “Generation C” on the industry. A sense of optimism echoed throughout the conference, supported by reports of continued hotel performance improvements in markets nationwide. Read on for some of highlights from NATHIC 2014.


New Brands
Established brands are plentiful in the current pipeline of new hotel supply, while new brands and brand concepts continue to emerge and gain traction. Many industry insiders—including keynote speaker Jack DeBoer, who originally conceived the Residence Inn, Summerfield Suites, Candlewood Suites, and Value Place lines of hotels and, most recently, the WaterWalk Apartments—believe that the limited availability of established brands brings about the creation of new ones. Some speakers, however, emphasized the connection between new brands and the focus on Millennials (the generation of people born in the 1980s or 1990s), particularly as these travelers tend to be aligned with brand concepts such as health and wellness and lifestyle hotels.

The “soft brand” concept, currently represented by Marriott’s Autograph Collection and the Curio – A Collection by Hilton, among others, will soon include a new competitor. Michael Palmeri, Senior Vice President of Acquisition and Development for Loews Hotels & Resorts, announced the company will be rolling out a new soft brand in the first quarter of 2015. These “soft brands” or collections of hotels offer travelers looking for cultural experiences in unique destinations the security of basic brand standards; they also offer owners the benefits of brand affiliation, especially distribution and reservation channels. Other supply trends noted at NATHIC included the growth of ground-up developments versus conversions and the increasing development of urban extended-stay properties.

Although new brands, independent hotels, lifestyle concepts, and softbranded hotels tend to target customers from specific segments, the number of emerging brands and concepts was on the minds of many attendees. During the panel on extended-stay hotels, Diane Mayer, Vice President & Global Brand Manager with Marriott International, stated that “as [the number of] brands proliferate, they get harder and harder to differentiate.” Hence, while many new brands are emerging in the market, the lack of brand recognition can hinder their acceptance by customers, especially as, from the perspective of guests, discernible differences or advantages among the newer concepts are less evident when compared with those among existing brands.

Millennials and the Content Generation
The shear size, youth, and technological savvy of the Millennial generation makes it a key target demographic in today’s hospitality market. Many NATHIC attendees and speakers recognized that no one brand is likely to corner the market on Millennials, which are composed of a great many physiographic segments. Still, even if brands targeting Millennials capture only a small, like-minded portion of the approximately 80 million members of the generation, this still presents a very substantial potential customer base.

Millennials represent a sort of paradox when it comes to what they want in a hotel. They have high expectations when it comes to lodging, but look for sleekness and simplicity in the experience as well. Millennials also favor innovative design at every price point, and they’re tech-savvy yet value driven. The term Generation C (or the “Content Generation”) was also used to capture the physiographic of customers at all ages who create and share content through YouTube, blogs, and other online avenues; the members of Generation C, which may extend even more widely than the Millennial generation, hone in intensely on hotel options that allow them to access and share content during their stay. No matter the term, the importance of offering exactly what the customer wants, without all the extras they don’t want to pay for, is key.


Higher Spends, Longer Stays, and Limited New Supply Boost Optimism

Hotel performance so far into 2014 has exceeded expectations and will likely end on a high note, with all segments anticipated to exceed RevPAR levels in 2007 (the pre-recession peak) and 2013. Overall, occupancy for 2014 is projected to reach 64.6% and to surpass 65% in 2015; STR Analytics noted occupancy hasn’t been so high since the 1990s. Average rates in 2015 are expected to experience all-time highs as well.

Increased consumer confidence, longer stays with higher spending per stay, and limited new supply have all contributed to increasing occupancy and strong average rate. As the Great Recession becomes a thing of the past, consumers are willing to pay a premium for additional amenities and convenience. There was also discussion of the linkage between these trends and the aforementioned tendencies among Millennials and Generation C. Many spoke to how today’s consumers are extending their travel periods, most notably through an added Thursday or Sunday night to create an extended weekend. These longer traveling periods are becoming more prevalent in today’s hotel industry, and it was also recognized that many customers are willing to spend more on each day of their trip.

Lodging Econometrics reported that the U.S. hotel industry entered the expansion phase of the lodging real estate cycle in 2014. However, supply growth is expected to be approximately 1.3% and 1.6% in 2014 and 2015, respectively, which is notably below the 20-year average of roughly 2.0%. Conversely, the exit of hotel rooms is also below the industry average, according to Lodging Econometrics. Year-to-date through October of 2014, approximately 19,500 rooms have left the supply report, with approximately 4,000 of those located in Atlantic City. The industry average of hotel rooms leaving the system is approximately 35,000 per year.


Outlook
NATHIC 2014 made it clear that the optimistic outlook for the next several years, especially 2015, is well deserved. The potential impact of new legislature, such as the Living Wage Law, along with the influx of new brands, is important to consider going forward. Overall, however, the fulcrum of the hospitality industry is on the upswing.

Historic tax credit sunset spurs jump in NC renovation proposals

A building that once hummed with the whir of more than 100 people operating 10,000 spindles now lies dormant, a relic of a time when cotton was king and trains were the lifeblood of Southern commerce.

More than a century old, the 55,000-square-foot Clayton Spinning Mill closed in 1976. Its faded brick facade shows its age, but its owners believe it has some life in it yet.

They hope to turn the building and the surrounding land into a sports and retail complex with the help of the state mill rehabilitation tax credit they were awarded earlier this year, which will offset the cost of renovating the historic structure.

“You can’t do a project like this without the tax credits unless you’re walking around with $10 million in your pocket,” said Michael Hubbard, who owns the mill with fellow Clayton resident Steve Yauch.

The mill credit will expire at the end of the year for properties that haven’t been approved to receive it. With a month and a half left to apply for eligibility, dozens of developers are scrambling to get approval for rehabilitation projects like the Clayton mill, massive undertakings that often can’t be completed without the state incentive.

Tim Simmons, federal rehabilitation tax credit coordinator and senior preservation architect at the State Historic Preservation Office, said the number of applications submitted this year began to rise during the summer.

“I know that this year, mill projects are up,” he said.

The mill credit is one of three historic preservation tax credits that the state legislature chose not to renew this year. The 20 to 30% credits for residential and commercial properties will expire Jan. 1, while the 30 to 40% credit for mills will expire only for projects that haven’t received state approval before the year’s end.

Enacted in 2006, the mill credit can be used in addition to the 20 percent federal historic preservation tax credit for the rehabilitation of properties on the National Register of Historic Places. To date, the incentive has aided in the completion of 28 mill projects — more than half of them in Durham and Winston-Salem — and 43 more have been proposed in counties across the state.

But not all potential projects will be deemed eligible before the deadline. Myrick Howard, president of Preservation North Carolina, said any mills not yet listed on the National Register may not receive the credit because the listing process usually takes about a year to complete.

“These projects are going to be really hard to do without any tax credits, and there is a good chance we’re going to see mills like that being deconstructed for materials,” he said. “That’s taking an economic development opportunity and taking it apart and throwing it away.”

On Friday, the N.C. Department of Cultural Resources announced that 17 properties in the state had been added to the National Register, including the Merrimon-Wynne House in Raleigh.

The decision not to renew the historic preservation program aligns with the goals of the 2013 Republican overhaul of the state tax code, which reduced income tax rates for individuals and businesses and eliminated other tax credits. Between 2006 and 2012, mill rehabilitation projects qualified for about $128 million in credits, according to State Historic Preservation Office data. The tax credits for commercial and residential properties, available since 1998, have cost the state more than $230 million since their inception.

Economic benefits

In his 2015 budget proposal, Gov. Pat McCrory included a less expensive version of the historic preservation program that reduced tax credit percentages and capped eligible rehabilitation expenditures at $20 million. The modified program would reduce its cost to the state by $10 million to $15 million annually, according to State Historic Preservation Office data.

The House supported the less expensive program, but the Senate did not. Sen. Bob Rucho, co-chair of the Senate Finance Committee, did not respond to several requests for comment.

“Tax credits are not an acceptable part of tax reform, so it hit a wall in the Senate,” Howard said.

He said he expects the legislature will consider implementing a version of the tax credit or an alternative incentive next year.

Proponents of the preservation program argue the economic benefit of rehabilitating historic mill structures far exceeds the initial cost to the state. The 28 mills rehabilitated with the help of the tax credit cost a total of $563 million to complete, and each supplies more jobs and tax revenue than it did before its renovation.

The American Tobacco Campus in Durham, a $167 million investment, stands as the largest project completed with the use of the mill credit. Capitol Broadcasting, which owns the campus, hired Durham-based Belk Architecture to transform the million-square-foot former cigarette production complex into mixed-use space home to shops, restaurants and office space.

The mill credit also allowed Belk Architecture to repurpose Durham’s Golden Belt complex, a seven-acre campus with an $8,000 tax value before its renovation. After it opened as a commercial and residential space in 2011, its tax value rose to $16 million.

The Chesterfield Building in Durham was also approved to receive the mill credit. The $100 million project, which will turn the former Liggett & Myers Co. cigarette production facility into commercial and office space, began earlier this year.

Retaining history

Eddie Belk, owner of Belk Architecture, said most mill rehabilitations aren’t possible without the help of the credit because the cost of preserving and repurposing a heritage building generally exceeds the amount of revenue the structure will generate while new tenants take root and build a customer base.

“The only way you can make a profit on these very large structures on many occasions is to invent a new enterprise and give it a new start,” he said. “The credits develop equity up front to help get the project done, and then it becomes a viable asset to the community.”

Though less extensive than many projects completed with the use of the tax credit, rehabilitation of the Clayton mill will cost $3 million to $5 million. The building’s 150 arched windows are bricked over, and restoring their original design could cost as much as $7,500 per window, Hubbard said.

Hubbard is looking to use both a 30 percent state mill credit and a 20 percent federal credit. If the project ends up costing $3 million, Hubbard estimates it could qualify for about $1 million in tax credits. While North Carolina buildings that are later added to the National Register will be able to apply for federal credits in the future, those often aren’t enough to make a project economically viable.

Renovating the Clayton mill without retaining as much of the original architecture would cost less and might not require the mill credit to complete. But Hubbard said he and and his team opted to preserve the integrity of a small-town fixture, a goal that resonates with some Clayton residents.

“When you find a new purpose for older buildings, you’re saving the history,” said Pam Baumgartner, historian at the Clayton Library and longtime resident. “Cotton was one of the first big industries here, and (the mill) really did have a big impact.”

Construction is expected to begin next year. Hubbard said he hopes the development will fill a need in Clayton, a town of nearly 18,000 whose population has increased by a third during the last decade.

“Clayton has boomed in its own right, and for the most part it’s starting to burst at the seams,” he said. “That’s why we’re looking at this project. It can be a destination for the town.”

Senate Fails to Renew Terrorism Insurance

A U.S. program that backstops insurance companies’ losses from acts of terrorism is set to end after the Senate didn’t extend it.

Efforts to reauthorize the Terrorism Risk Insurance Act for six years fell apart after Senator Tom Coburn, an Oklahoma Republican who is retiring, held up the legislation. Without a renewal, the program will expire Dec. 31.

“It’s unfortunate, but his objection is going to kill TRIA,” Majority Leader Harry Reid, a Nevada Democrat, said last night on the Senate floor. “I’m very sorry about that, but it’s a fact.”

The House passed an extension on Dec. 10 that would reimburse insurers after industrywide losses reach $200 million. The House measure would increase companies’ co-payments to 20 percent from 15 percent and gradually raise the threshold for government involvement.

Congress first passed the backstop after the terrorist attacks of Sept. 11, 2001, when insurers said they were hesitant to sell coverage on New York City office buildings. Coburn’s objection stemmed from concerns over the underlying policy and a plan to set up a regulatory body to supervise insurance agents and brokers (the National Association of Registered Agents and Brokers Reform Act or NARAB).

Taxpayers assume most of the risk while “the insurance industry makes all the money,” Coburn said last night.

Energy Companies

The bill passed by the House includes a change to the 2010 Dodd-Frank banking regulation law to exempt agricultural and energy companies from having to post collateral for swaps that are traded directly with banks and not guaranteed at a third- party clearinghouse.

The measure also would require that the Federal Reserve include a governor with community banking experience.

Fifty-seven business organizations, including the National Association of Realtors and Hilton Worldwide Holdings Inc., sent a letter to senators on Dec. 14 urging passage of the terrorism insurance law without other amendments. The groups said the program ensures “economic resiliency in the event of a terror attack.”

Without a reauthorization of TRIA, insurers will have the right to cancel terrorism policies after Jan. 1, Howard Kunreuther and Erwann Michel-Kerjan wrote for Bloomberg Businessweek in the Dec. 9 issue. They are likely to do so for fear of insolvency should a massive terrorist attack take place with no government backup, according to the two academics, who wrote a paper on the law’s impact for the Wharton Risk Center.

Kunreuther and Michel-Kerjan asserted that a lapse could lead to cancellation of events such as the Super Bowl, a contention disputed by the National Football League.

“The Super Bowl will be played,” Greg Aiello, the NFL’s senior vice president of communications, said in a statement reported by news organizations including ABC and CNN.

The legislation is S. 2244.

The Property Casualty Insurers Association of America (PCI) today issued the following statement expressing its disappointment in the failure to renew the prorgam:

“It is unconscionable that the U.S. Senate would adjourn without finishing their job and reauthorizing a long-term Terrorism Risk Insurance Act (TRIA) when the threat of a terrorist attack against the United States is at the highest level it has been in a decade,” said David A. Sampson, PCI’s president and CEO. “TRIA plays a vital role in our national economic security. If a massive attack occurs before TRIA is reauthorized, there could be no terrorism insurance coverage or taxpayer protection. PCI is profoundly disappointed by the dysfunction in Washington and we urge the next Congress to address a long-term reauthorization of TRIA immediately when they convene in January.”

EB-5 Foreign Investors are Favoring Senior Housing

Despite recent criticism for perceived lack of supervision, the U.S. Immigrant Investor Program, or EB-5, is a popular way to boost investment in seniors housing development.

EB-5 was created by Congress in 1990 to stimulate the economy through job creation and capital investment by foreign investors. The program grants permanent resident visas (green cards) to foreigners who invest at least $1 million ($500,000 in low-employment areas) into a new or failing company and create at least 10 new full-time jobs -- and is facing some negative press. Fortune magazine recently ran a cover story on an Indian investor who tried to make millions of fake projects through EB-5. Other EB-5 projects have yet to repay investors, like Jay Peak, a Vermont resort.

Recently, PDC Capital Group, in Costa Mesa, Calif., announced that it will invest $750 million in new senior properties through 2017. PDC's investment in 25 new SummerPlace Assisted Living & Memory Care residences includes over $250 million from EB-5 visa seekers. Groundbreaking took place at $26 million SummerPlace Lincoln, a 228-bed facility in Sacramento, Calif., that PDC says will create 135 new jobs.

PDC CEO Emilio Francisco says seniors housing creates the least risk for green card seekers because it strongly impacts jobs and communities. The average senior housing development costs $30 million, he says. EB-5 investment represents 20% to 30% of the capital stack, or $10 million per facility.

EB-5 calls for "regional centers" that coordinate foreign investment. The centers must focus on a contiguous geographic area and promote economic growth through jobs creation, improvised productivity, and increased export sales and domestic capital investment. The number of EB-5 applicants has skyrocketed. There were less than 100 approved centers in 2010; as of June, the USCIS had approved 579 new centers in total.

Omega Communities LLC, in Birmingham, Ala., has centers in Florida and Puerto Rico. COO James Taylor Jr. says the Florida center creates almost 30 new jobs per investor. Omega focuses on senior housing development and acquisition, putting together the capital stack, then bringing EB-5 investors. "It allows us to move much more quickly because the USCIS can be unpredictable in its approval times, and it's beneficial to go to a foreign country and show them a capital stack already in place to operate it for two years without additional funds," he says. "They get significantly more comfort that the project is viable and will be successful, they'll be more likely to get their investment back -- and also their green card."

Taylor says most EB-5 investors are Chinese, and are knowledgeable about the world supply-demand curve for seniors’ properties. Plus, China has its own senior housing crisis, due to its single-child mandate.

San Jose, Calif.-based NES Financial has 250 EB-5 projects with $10 billion in capital, and administers EB-5's Global Premier America Regional Center in California and projects by RockBridge Senior Living Group. Executive Vice President Reid Thomas says about 85% of NEB's EB-5 money comes from China. "There's a lot of positives about this investment vehicle -- and it doesn't cost the U.S. taxpayer a dime."

An S&P Ban Seen Having Big CMBS Impact

Word that the SEC may suspend S&P from rating commercial MBS transactions sent a shudder through the sector this week.

CMBS lenders said a ban would have a major negative impact on the single-borrower market, where S&P is the dominant rating agency. CMBS shops would likely have to turn to Moody’s or Fitch, which generally take a harder credit-quality stance on single-borrower deals. That would result in smaller loan sizes or higher interest rates, which could depress CMBS issuance by driving borrowers to other types of lenders or by rendering some acquisitions and refinancings uneconomical.

The secondary-market impact could also be significant if an SEC action voided S&P’s outstanding ratings during a suspension. That could force investors whose guidelines require a rating from a major agency to dump bonds, depressing prices.

Bloomberg reported on Monday that the SEC "is seeking to suspend" S&P from rating CMBS transactions. The news agency added that S&P was holding settlement talks in an effort to avoid the sanction.

Nomura researchers speculated that a ban could last one year. The SEC and S&P declined to comment.

The exact nature of the SEC’s investigation is unclear. In July, S&P disclosed that it was being investigated for possible violations of federal securities laws connected to its ratings and disclosures for six CMBS transactions in 2011. Bloomberg said the SEC was investigating whether S&P "bent rating criteria to win business."

Given the uncertainty about the likelihood, scope, timing and length of any SEC sanction, CMBS lenders said they were taking a wait-and-see attitude for now, continuing to quote loan terms on the expectation that S&P will rate transactions. But they acknowledged that they risk taking losses on loans being warehoused when an SEC action is announced.

Likewise, traders said the Bloomberg report had no immediate impact on prices in secondary-market trading.

S&P has almost disappeared from the conduit market because of a series of missteps since the crash and issuer complaints that its methodology doesn’t produce consistent rating patterns. But that same methodology produces relatively favorable credit-enhancement levels on single-borrower transactions, enabling lenders to write larger loans at lower rates. That has made S&P the dominant agency in that sector, with an 81% market share this year, versus 19% apiece for Moody’s and Fitch. Single-borrower transactions account for one-quarter of overall U.S. issuance.

But if S&P isn’t used, a lower percentage of a loan would qualify for an investment-grade rating. That would force a property owner to either borrow less or use mezzanine financing to make up the difference, increasing the blended coupon.

Lenders said the impact would vary widely from loan to loan, but as examples, they said that leverage ratios might decrease to 65% from 70%, and coupons might rise by 25-75 bp. Borrowers would then have to decide whether to pay the higher cost, borrow less, turn to another lender or not proceed at all.

Senior CMBS executives were glum about the prospect of a suspension. One said it would have "a major impact." Another said it would make "a material difference." A third said it would "cast a dark cloud over the CMBS market."

One veteran in the large-loan market said that profits have already been squeezed by increased lending competition this year. "We’ve been skating on thin ice as it is," he said. "If S&P goes away, it’s going to make this business extremely tough."

"Stand-alone deals will still get done," said another lender, "but it means the whole pipeline will have to get re-priced. If it

happens suddenly, there will be some people who’ll get stuck. They’ll have priced a deal a certain way, then find they have to change directions mid-stream. That’s where the pain will occur."

For the secondary market, the worst-case scenario is that S&P would be forced to withdraw its rating on outstanding bonds. Some buy-side shops have investment guidelines requiring that bonds carry a rating from S&P, Moody’s or Fitch. So if S&P’s ratings are dropped and neither of the other agencies rates the bonds, those investors could be forced to sell.

"If [S&P has] to take all their prior ratings off, that would be a problem," said one CMBS trader. But another trader noted that since the market crash, some institutional investors have dropped the requirement of having a rating from the traditional "big three." And the impact would largely be limited to post-crash single-borrower transactions.

So far, secondary-market prices haven’t been affected. This week, unrelated to the Bloomberg report, an unidentified holder sold about $55 million of single-borrower CMBS rated in most cases by S&P but not the two other major agencies. All of the bonds traded at levels that met or exceeded price talk circulated by dealers.

The SEC’s investigation is believed to stem at least partly from a controversial incident in July 2011, when S&P abruptly withdrew its ratings on a $1.5 billion CMBS transaction that had already priced and was about to settle. The unprecedented action derailed the multi-borrower transaction and caused issuers

Goldman Sachs and Citigroup to lose millions, touching off a firestorm of criticism in the industry and prompting angry issuers to boycott the agency on conduit transactions.

S&P attributed the unprecedented action to the discovery of a possible inconsistency in how its analysts had been calculating the debt-service-coverage ratios for new and legacy transactions.

Commercial mortgage delinquencies returning to prerecession levels

The delinquency rates of most types of commercial and multifamily mortgages fell in the third quarter, with multifamily loan delinquency rates back at prerecession levels, according to Mortgage Bankers Association (MBA) research.

The 30-day delinquency rate for commercial mortgage-backed securities (CMBS) loans was down 0.37 percentage points to 5.47%. The 60-day delinquency rate of commercial and multifamily loans held by life insurance companies fell 0.03 percentage points to 0.05%.

The 60-day delinquency rate for multifamily loans backed by Fannie Mae decreased to 0.09%, while the 60-day rate for Freddie Mac multifamily loans increased 0.01 percentage points to 0.03%.

The post-recession highs for Fannie Mae and Freddie Mac multifamily delinquency rates occurred around 2010. In the fourth quarter of 2010, the 60-plus day delinquency rate for Fannie Mae was 0.71%, and was 0.33% in the third quarter of 2011 for Freddie Mac.

In the fourth quarter of 2006, the Fannie Mae 60-day delinquency rate was 0.08%, and the Freddie Mac rate was 0.05%.

Some delinquency rates were still above recession-era peaks. Approximately 1.28% of loans held by the Federal Deposit Insurance Corp. and banks were delinquent 90 or more days in the third quarter. That delinquency rate peaked between 2010 and 2011 at above 4%, with the low at 0.8% around mid-2006.

CMBS 30-plus and real estate owned (REO) delinquency rates stood at just above 5% in the third quarter. The peak was in 2011 at close to 9%. Between 1997 and 2009, CMBS delinquencies were below 2%.

“Improving property fundamentals and values, as well as a strong finance market, are helping drive delinquency rates down across all investor groups,” said MBA Vice President of Commercial Real Estate Research Jamie Woodwell in a press release.