Soaring CMBS spreads highlight new risks on both sides of the Atlantic

Widening CMBS spreads on both sides of the Atlantic reflect an uptick in supply but also highlight that investors are increasingly wary of the latest structures and collateral, and are demanding higher compensation as a result.

Data show US spreads have widened to their highest levels in almost two years, while the latest pricing from Europe - Deco-2015 Charlemagne, a multi-jurisdiction deal - illustrates that issuers need to pay hefty premiums to place non-Triple A bonds.

Market sources told IFR this reflected heightened investor awareness of the risks ratcheting up in CMBS deals. "Complexity is creeping back into the structure and the general quality of the collateral has been deteriorating," a European investor said.

After the financial crunch, European issuers soothed investors with straightforward structures, simple collateral such as German multi-family properties, and strong sponsors. But over time they slowly reinserted risk into the deals - with weaker sponsors and secondary/tertiary properties.

"The first post-crisis issues were really investor-friendly, but this is becoming less and less the case now, which is causing investors to take a step back," one investor said.

US conduit CMBS spreads on new-issue deals rated Single A- rose as high as 275bp in July from as low as 190bp in April, according to Morgan Stanley data. The last time spreads in the middle of the capital structure were this wide was the third quarter of 2013, according to JP Morgan data.

Another factor pushing pricing power back into the hands of investors is that issuers that exclude unfavourable ratings on lower-rung tranches end up paying for it. They are able to demand beefier margins for tranches that fail to get solid ratings from at least one major agency, according to Bank of America Merrill Lynch analyst Alan Todd.

Investors Less Naive

That trend, which Todd said had now more clearly crystallised since mid-May, might indicate that investors are less naive about the quality of the underlying collateral.

The fact that, contrary to other asset classes, the CMBS segment has not bounced back from heightened global economic uncertainties - specifically negative Greek and Chinese headlines in early summer - would appear to confirm this.

With Greek debt woes on the backburner, CMBS spreads have continued to languish at wider levels. Growing concerns over real estate loan underwriting standards could explain this, one investor at a New York-based asset manager said.

"I continue to be surprised by what I see getting underwritten."

The US investor said the continued onslaught of new deals had also kept pressure on spreads. CMBS issuance of US$71bn this year is running 26% higher than the same period of 2014, according to Bank of America Merrill Lynch data.

The European primary has also witnessed a surge in supply - with two deals pricing in the same week for the first time since the crisis. Deutsche Bank had to pay plus 525bp on BBB-/BB bonds and plus 425bp on BBB+/BBB notes at the end of July to place its Deco-2015 Charlemagne deal - 145bp more than initial talk.

Single As were also priced significantly wider to initial levels, at 290bp against 220bp.

While the two bankers blamed the painful results on general market weakness and mounting CMBS supply, the European investor was more suspicious, saying: "Investors may not want to spend their time taking a long hard look at CMBS structures and collateral that have wrinkles in them." 

Financing commercial real estate is getting faster, easier in Detroit

Eight long, grueling years.

That's how long it's been since one of the most complicated redevelopment financing structures in Motown's history was cobbled together for the $180 million renovation of the Westin Book Cadillac Detroit on Washington Boulevard at Michigan Avenue.

Involving 17 layers of financing, the deal was so complex that one real estate financing expert at the time said it could have been the subject of a master's degree thesis.

But the Book Cadillac wasn't an anomaly. Labyrinthine financing plans are what it has taken to get projects done in the Motor City — even in the resurging downtown and Midtown districts.

It took George Stewart and Michael Byrd 15 years and eight funding sources to complete the overhaul of the Woodward Garden block of Woodward Avenue into a $44 million mixed-use development with multifamily residential, retail and office space in Midtown.

Richard Karp is redeveloping three Capitol Park buildings, and the financing for just one of the projects involves 11 different capital stacks.

But the market is starting to shift. These days — post-recession, post-Kwame, soon-to-be post-bankruptcy — the real estate community is noticing smoother paths to securing financing, particularly for in-demand multifamily housing in the booming downtown and Midtown areas.

Richard Hosey III, a former senior vice president for Bank of America who is now the owner of Detroit-based Hosey Development LLC, said there is a sense among developers and lenders that most redevelopment projects are financially feasible, whereas just a few years ago questions were rampant about whether enough demand existed.

"People talk about closing and financing gaps more so than "it's just not possible' or that there won't be demand," said Hosey, who worked on the financing for the $53 million redevelopment of the 35-story Broderick Tower into a 127-unit apartment building, another complex financing project, among others.

"Even if it's nine layers (of financing), it's nine straight-forward and easy to replicate layers so we can pass it along to the next project," he said.

Part of what is helping is that average rental rates are slowly but steadily creeping toward the $2 per square foot levels, which makes traditional lenders more willing to finance projects.

"After we clear that mark and have been doing that for a number of years, I think lenders will say it wasn't a fluke, that there actually is a strong market for this product," said James Van Dyke, vice president of development for the Detroit-based Roxbury Group, which redeveloped the David Whitney Building, the former Globe Trading Co. building for the Michigan Department of Natural Resources, as well as a host of other projects.

The David Whitney Building, which is scheduled to be completed this year after a two-year conversion into 108 multifamily units and a 135-room Aloft boutique hotel, is an $82.5 million project involving funding from the state, Bank of America, the Downtown Development Authority and others.

Earlier this year, the Detroit Economic Growth Corp. received approval from the DDA to negotiate a development agreement for The Griswold apartment development. Roxbury plans on using only three funding sources for the $22 million development, which would have 80 units atop a 10-story parking garage and retail building at Griswold Street and Michigan Avenue.

Increased willingness to finance Motor City redevelopment efforts is welcome news to Joseph Kopietz, a member in the Detroit office of Clark Hill PLC, who advised the College for Creative Studies on financing for the A. Alfred Taubman Center for Design Education project, among many others.

But still, it's not like lenders are frothing at the mouth to take what might still be a gamble on Detroit projects, he said. It remains a complex chess game, oftentimes involving many lenders and tax incentives, such as the U.S. Department of Housing and Urban Development's 221(d)4 Program, Michigan Strategic Fund's Community Revitalization Program, state brownfield tax credits and tax credits at the state and federal level for historic preservation.

"Because of various factors, having seven layers of financing can sometimes be more complex than 12," he said. "Each type of financing has its own complexity, and we still are not at a state here in Detroit, nor in many other major markets, where financing of significant projects is getting any easier."

Yet all told, Kopietz and others remain optimistic.

"We are going to continue to get some questioning and scrutiny from lenders and equity partners, but things have been improving. What people are seeing is the successes in Detroit that we've had here recently, and that's good for the market," he said.

Ariz. Hotel Appraised Value Cut by 2/3

The 347-room Phoenix Airport Marriott, whose $63.8 million CMBS loan was transferred to special servicing last April, has been appraised at a value of $29.4 million. According to Barclays Capital, which highlighted the latest appraisal in a recent research note, the loan also became delinquent this month. The property originally was appraised at a value of $94.7 million.

The hotel, at 1101 North 44th St., near Phoenix’s Sky Harbor Airport and the campus of Arizona State University, was constructed in 1999. It is owned by Columbia Sussex of Crestview Hills, Ky., which until this month had kept the loan current, even though the property wasn’t generating sufficient cash flow.

Last year, for instance, the property generated $3.6 million of cash flow. That was 30 percent less than the amount required to fully service its loan, which was securitized through Banc of America

Commercial Mortgage Trust, 2006-3.

Barclays noted that the new, lower appraised value will lead to an appraisal reduction of about $35 million, which could increase interest shortfalls by $184,000. The deal’s A-J class, originally rated AAA by Standard & Poor’s and Fitch, would see an increase in shortfalls.

This month, the class was shorted $108,448 of interest. In addition, Barclays said that if the hotel was liquidated at near its appraised value, the deal’s class B, with a balance of $36.9 million and the most junior remaining in the deal, could be wiped out entirely and the A-J class could see a loss. The team added that the shortfalls, if they occur at that level, would be short-lived.

$278.1Bln of Conduit Loans Mature in ‘15-’17

A total of 22,514 CMBS conduit loans with a balance of $278.1 billion come due in the next three years. While a seemingly massive wall of maturities, the volume has shrunk by nearly 10 percent over the past nine months. And given continued favorable lending market conditions, it’s likely to continue shrinking.

Indeed, just about every major investor group has increased its holdings of commercial mortgages, according to recent data from the Mortgage Bankers Association, which found that the universe of outstanding commercial mortgages increased by 1 percent during the second quarter to $2.6 trillion.

Banks and thrifts, the largest holders of mortgages, saw their inventory of loans increase by a robust 1.8 percent over the first quarter, to $929.9 billion. CMBS and other securitized vehicles saw their inventory decline to $532.9 billion. That’s largely due to the fact that run-off outpaced new originations - at least through the second quarter. Life-insurance companies, meanwhile, saw a 1.3 percent increase in their inventories, to $345.8 billion.

The open lending spigots have led to a steady pace of loan pay-offs - a big chunk of the loans being securitized today were written to refinance existing CMBS loans - as well as a sharp increase in the volume of defeasance, where loan collateral is replaced by government securities.

Wells Fargo Securities noted that so far this year $12.4 billion of CMBS loans have been defeased, or replaced by government securities. That compares with a volume of $11.3 billion for all of last year and amounts to a near doubling of the $6.4 billion of volume recorded during the year’s first half.

Next year, 6,263 conduit loans with a balance of $64.6 billion come due. In 2016, that increases to 8,230 loans with a balance of $104.3 billion and in 2017, 8,021 loans with a balance of $109.2 billion come due. The volume excludes loans that have been defeased. Because those are backed by government securities, they aren’t at risk of defaulting at maturity.

Even though the volume of loans that mature between 2015 and 2017 steadily has been declining, many of the remaining loans could pose challenges. The thinking has been that loans that easily could be refinanced would have been by now, simply because interest rates are lower than they were when the current crop of maturities were written.

A total of 9,482 loans with a balance of $153.8 billion, or 55 percent of the loans that mature during the 2015-2017 period, have debt yields of 10 percent or less, based on the latest available net operating income figures as compiled by Trepp LLC.

A loan’s debt yield is calculated by dividing a collateral property’s NOI by its loan’s balance and is a gauge used to determine how comfortably the property can carry its debt.

Meanwhile, the collateral for 5,351 loans with a balance of $64.9 billion generates less than 10 percent more than what’s needed to fully service their securitized loans. In other words, their debt-service coverage ratios are less than 1.1x. Lenders typically prefer loans whose collateral can generate 120 percent, or 1.2x, the cash flow needed to fully service their borrowings.

Using DSCR as a gauge, office loans could face the biggest challenges in refinancing, as 1,209 of the loans coming due between 2015 and 2017, with a balance of $27.6 billion have DSCRs of less than 1.1x. Of the retail loans that will be coming due between those years, 1,941 with a balance of $22.8 billion have DSCRs of less than 1.1x.

Among those that might face challenges are the $200 million loan, securitized through Banc of America Commercial Mortgage Trust, 2005-3, against the Woolworth Building in Manhattan. The 811,791-square-foot office property last year generated $12.7 million of net cash flow, which is about 20 percent more than that needed to fully service its non-amortizing loan. But the $13.6 million of NOI it produced results in a debt yield of only 6.8 percent. The well-leased property also supports $50 million of additional debt. And its largest tenant, the General Services Administration, occupies its 112,692 sf under a lease that matures next October. It leases its space on behalf of the SEC, which had reduced its footprint in the building when its lease originally matured two years ago.

Shares of Blackstone-Backed Real Estate Trust Rise in Debut

Summary:  Blackstone owned REIT, Brixmor Property Group, oversold in its IPO.

New York --(New York Times DealBook)--

Stock market investors continue to show an appetite for real estate.

The Brixmor Property Group, a real estate investment trust owned by the Blackstone Group, sold more shares than it had expected in its initial public offering on Tuesday evening, reflecting strong demand from investors. The shares were priced at $20 each, the middle of an expected range, raising $825 million and giving the company a market value of about $5.9 billion.

The stock rose on Wednesday in the company’s trading debut on the New York Stock Exchange. After opening at $20.65, shares of Brixmor were up as much as 4 percent during the day before closing at $20.40.

“Our story really resonated with investors, and that led to more demand that allowed us to upsize,” Michael A. Carroll, the chief executive of Brixmor, said in an interview.

Investors are looking to gain exposure to the strengthening commercial real estate market in the United States. Vacancy rates are expected to decline for commercial properties and rents are expected to grow modestly, the National Association of Realtors said in a forecast released in August.

In October, the Empire State Realty Trust raised $929.5 million in an initial public offering. Its shares, through Tuesday, have risen 9 percent from the I.P.O. price.

Investors are betting that Brixmor, which has 522 shopping centers across the country, is poised to benefit from the improving property market. The company says it has the nation’s largest wholly owned portfolio of shopping centers anchored by grocery stores.

The company, formerly known as the Centro Properties Group, was in need of capital before Blackstone bought it in 2011. Since then, Brixmor has invested $339 million to improve its assets, the company said in a regulatory filing.

Brixmor said it planned to use the proceeds from the offering to reduce its debt. As of June 30, its total debt was about $6.7 billion, according to the filing.

The company sold 41.3 million shares in the offering, more than the 37.5 million shares it had expected to sell. The deal’s underwriters have the option to purchase an additional 6.2 million shares.

Blackstone will remain the majority owner, with about 73 percent of the company’s shares, according to a filing.

The offering was led by Bank of America Merrill Lynch, Citigroup, JPMorgan Chase and Wells Fargo Securities.

http://dealbook.nytimes.com/2013/10/30/shares-of-blackstone-backed-real-estate-trust-rise-in-debut/?_r=0