Each month seems to bring record-breaking low rate

Like the ants in the kid's song "The Ants Go Marching," commercial mortgage rates are marching down, into the ground, to get out of the storm.

As poor corporate earnings reports and dismal economic news provided no respite from the storm that equity and bond markets are experiencing, the 10-year U.S. Treasury yield continued its three-month long march downward.

Indeed, rates for 5- and 10-year mortgages went lower last month and now are slightly lower than 5 percent for 5-year mortgages and range from 5.50 percent to 5.75 percent for 10-year mortgages, according to the Barron's/Levy Commercial Mortgage Survey.

In 2001, Barry Bonds hit 73 home runs, and each home run after 70 was record breaking. Likewise, each month seems to bring record-breaking commercial mortgage rates, and borrowers are responding.

The commercial mortgage-backed securities market has seen a surge of activity lately, with more than $3.2 billion in bonds selling in the last week of September alone. (Wall Street bundles commercial mortgages together and sells the commercial mortgage-backed securities, known as CMBS, to investors.)

Investors gobbled up the large supply of bonds and seem to have a large appetite for the real estate- secured products.

However, with a steady flow of bad news about the economy and corporate restructurings, some investors are starting to question when loan defaults are going to pick up.

One of the larger default risks for lenders is a property leased to a single tenant. It's an all or nothing proposition - the tenant is either paying rent, and therefore the landlord is paying the mortgage, or the tenant is not, and there's a problem.

A prime example of this all-or-nothing circumstance is Kmart leased properties where the bankrupt company shut down a number of stores and canceled the leases while keeping other stores open and continued paying rent.

Earlier this year, the question of who suffers the loss when Kmart stops paying rent was answered in the case of seven Kmart shopping centers owned by Kimco Realty, a publicly traded A3-credit rated company.

Kimco decided to stop paying the lender one month after Kmart stopped paying rent. The Kmart loans had been bundled into a CMBS offering and sold to investors.

Although Kimco is legally within its rights, the move has CMBS investors in a rage. "The actions are not consistent with what the market expects from an A-rated company," said Mark Streeter of JP Morgan.

Another area of heightened default concern for lenders has been with office properties, where the national trend has been increasing vacancies.

Locally, the markets have mirrored the national downturn, with vacancies hovering around 15 percent and new leasing activity slow.

Bucking this trend however, is the former Reynolds Metals headquarters that Alcoa sold in pieces to the University of Richmond and an investor group led by members of the Reynolds family.

The piece sold to the Reynolds investor group encompassed approximately 245,000 square feet of office space and additional land to accommodate 1.3 million square feet of new development.

According to Sargeant Reynolds, who is managing the project for the investor group, leasing activity has been very good.

"We've done almost 100,000 square feet of leasing in the past few months," he said. He attributes the strong activity to the location and recently completed projects near the property.

Andrew Little is an investment banker with John B. Levy & Co.