The five-year commercial mortgage-backed securities conduit loan is increasingly becoming a short-term lifeline for sponsors in the office and retail sectors who believe their property has a long-term future but is being affected by economic and interest rate volatility and banks scaling back lending.
This interest is a shift from what was seen prior to the start of the covid-19 pandemic, says Charles Foschini, a managing director at New York-based advisory Berkadia.
“In much of this cycle, starting with the global financial crisis, CMBS loan was a loan of last resort,” Foschini says. “Borrowers had learned that once the loan was originated and securitized, it was clunky to deal with a servicer who was trained to say ‘no’ [to any requests]. No one was a champion of the loan and the asset as it was originally done.”
But this is changing as borrowers need near-term solutions to maturity problems.
“The market is in a state of high flux and volatility and there is a lot of pressure on banks to raise capital reserves, so they are not lending. There is a lot of pressure on life [insurance] companies, which are concerned, because they are asset-based lenders, about their own portfolios and are reluctant to lend. Fannie Mae and Freddie Mac remain active in the market but only lend on multifamily,” Foschini says.
Case study: One Eleven, Orlando
Berkadia earlier this month secured a $40.7 million commercial mortgage-backed securities loan to capitalize One Eleven, a 30-story mixed-use tower in Orlando. The sponsor was Lincoln Orlando Holdings, with Morgan Stanley providing a five-year, full-term interest-only CMBS loan.
“When our client looked at interest rate volatility, combined with where the economy was and the current view on office as an asset class, they decided a five-year loan would give them mid-term flexibility in the hope that as the economy got better and the view on office investments improved, they could pivot their assets into a much different loan down the road,” Foschini says.
The 2008 vintage property is located at 111 East Washington Street and includes a mix of 11,076 square feet of ground floor retail, nine levels of parking, 152,360 square feet of Class A office space and 164 luxury apartments. Right now, even for lower-leveraged, quality office and retail properties, a CMBS bid is the best – and sometimes the only – bid available, Foschini says.
“The benefit of a CMBS execution is that a CMBS loan is not an asset-based loan,” Foschini says. “The loan becomes pooled with other loans. If you were an asset-based lender and you did one office loan, that stands on its own. If you’re a CMBS lender, you could put that office loan with loans from other sectors and amortize that risk with different investments with different risk profiles.”
Borrowers have historically had a conflicted relationship with CMBS, Foschini adds.
“What may make a loan difficult to deal with after its origination is the same structure that allows for higher proceeds and an execution where other lenders won’t go. CMBS, a Wall Street-oriented vehicle, has historically been useful in creating liquidity but also proved to be very problematic in the last downturn. But it is coming back into vogue, out of necessity,” Foschini adds.
What is the outlook?
While CMBS issuance has been muted this year, Foschini believes more sponsors will start to opt for five-year conduit loans. There was just $10 billion of domestic, private label CMBS issuance in the second quarter, bringing the full-year total to $16.47 billion, according to data from New York-based data provider Trepp. This is about one-third of the roughly $50 billion of issuance seen in the first half of 2022.
“If you are looking at interest rates, as many people are today, and are concerned about them going higher or believe they may settle back and go lower, the five-year term has a lower prepayment by virtue of its shorter duration. It does not necessarily have a flexible prepayment, but you can prepay it sooner because you are only going out five years,” Foschini says. “I believe that story will replay itself many times as we get through the real estate and economic cycle in the US.”
There is no shortage of liquidity for debt, equity or rescue capital. “The reluctance is for that capital to go into a transaction because the market is so volatile it is hard for a debt or equity investor to value the investment they’re about to make. Because the market is so volatile or fragile, it is often hard to tell who the best lender will be at the outset of an assignment,” Foschini says.