Commercial Mortgages: What’s on tap now that the Fed has raised rates

Richmond Times-Dispatch

Posted: Sunday, December 20, 2015 10:30 pm

Investors seem to be crooning Willie Nelson’s “The Party’s Over” song lately.

Thinking that all good things must come to an end, many are hunkering down for a storm seemingly before the clouds have begun to darken.

The fact that the Federal Reserve raised the interest rates range by 0.25 percent for the first time in nine years should be interpreted as a positive sign that the economy is doing better, but market sentiment is decidedly negative.

Perhaps the greatest carnage is being experienced in the low grade or “junk” bond market, particularly in oil-related companies. The repercussions, however, are much more widespread.

As a result, bond investors in the commercial mortgage backed securities market are demanding prices on AAA bonds that haven’t been offered in more than three years, and conduit lenders have little ability to resist the widening.

In an interesting twist earlier in the month, several deal managers decided to pull offerings because pricing was not where they had hoped.

This rare push-back seems to offer some hope that at least some market participants think the price widening is temporary.

UBS, Morgan Stanley and Bank of America muddled through their offering and were saddled with AAA pricing that had not been as wide since mid-2012, according to Commercial Mortgage Alert.

Pricing recovered slightly on the ensuing two deals, but there is distinct lack of buyer interest in the market.

When combined with the typical end-of-year lack of lending appetite from insurance companies, borrowers are scratching their heads over what to expect as the page turns on 2015 and they look at 2016.

From the perspective of many life insurance companies, mortgage investments are still attractive and allocations for 2016 should be higher than 2015, so that leg of the lending stool is solid.

Banks also are increasing their appetites and should play a strong role in the new year.

Fannie Mae and Freddie Mac also got a surprise boost recently when their overseer announced that each would have slightly higher allocations in 2016 than in 2015, a combined $62 billion limit versus the $60 billion limit currently in place.

The weak sister unfortunately is commercial mortgage backed securities lenders. The combination of new SEC regulations, more conservative first-loss investors and wide bond pricing is threatening to cripple the industry just as the so-called wall of maturities hits in the next two years.

Commercial mortgage backed securities volume peaked in 2006 and 2007 for 10-year loans and those loans are expected to come due in the next two years.

Commercial mortgage rates are down from last month for top rated mortgages, but up slightly for conduit quality loans, according to the John B. Levy & Co. Mortgage Survey.

Top quality 5- and 10-year loans now range from 3.3 to 3.8 percent, respectively. Full leverage 10-year conduit loans are pricing closer to 5 percent.


Several loans secured by Richmond assets are included in the wall of maturities hitting the market in 2016.

Probably the largest question mark surrounds the workout and pending loan modification for the loan on the James Center.

The 974,268-square-foot set of three buildings at the James Center complex in downtown Richmond is facing a $150 million loan maturity in January, according to Trepp LLC, a New York-based information firm for commercial real estate and banking industries.

The loan per square foot is roughly equivalent to the expected sales price per square foot of Riverfront Plaza, another Richmond office tower that is reportedly under contract to be sold.

The twin tower of Riverfront Plaza is currently controlled by Hines REIT, a public non-traded company affiliated with Hines Interests based in Houston.

The 950,475-square-foot buildings were purchased in 2006 for $277.5 million. Recent filings by the REIT indicate the value was impaired and the asset was written down by $27.9 million for the nine months ended Sept. 30, 2014, and $38.8 million in the nine months ended Sept. 30, 2015.

It would appear an additional write down will occur when the building trades.

In a Dickensian tale of two fortunes, these two iconic multi-tenant buildings are facing difficulty while newer single-tenant buildings are selling for eye-popping numbers.

The Gateway Plaza building sold this month as planned to Lexington Realty Trust, a New York-based real estate investment trust. It sold at more than $315 a square foot with additional payouts available to the developer related to leasing that could push the price up.

And the Williams Mullen building is reportedly under contract to be sold for $371 a square foot.

John B. Levy & Co. investment banker Andrew Little can be reached at [email protected]


Saul Ewing Real Estate Conference Charts Ongoing Changes in CRE Business

November 9, 2015
The 300 or so real estate investors, brokers and developers who attended the Saul Ewing Real Estate Conference at the Baltimore Convention Center last week were in a decidedly positive frame of mind, and for good reason. Many industry observers consider the current market to be as good as it gets in real estate, with plentiful financing options, declining vacancies and increasing rents and ROI's.

The one complaint among attendees was that the favorable conditions meant more competition, be it for listing agreements, investment sales or providing financing. The generally upbeat atmosphere was a far cry from the conference's first year in 2008, when the Baltimore market, as well as much of the U.S. was just beginning to emerge from a paralyzing recession.

"We've certainly come a long way," noted Howard R. Majev, a partner in Saul Ewing's real estate practice and one of the lead organizers of the annual conference. "These things move in cycles so it's good that we come together each year to talk about new challenges and opportunities. Creativity is the common thread. There will always be opportunity for creative approaches to investing, lending and developing."

The conference featured panels on several much-discussed real estate topics, including new development options, Millennials' real estate choices and the gravity-defying multifamily sector.

However, much interest among attendees was focused on the financing panel, which featured two traditional lenders, Tony Marquez, executive vice president and chief real estate lender for EagleBank, Kieran Quinn, managing director for institutional lender Guggenheim Partners, and an upstart real estate crowdsourcing firm, Fundrise, represented by founding member, chief operating officer and head of product Brandon Jenkins.

Panel moderator John B. Levy, president of his namesake investment banking firm, deftly quizzed the panelists on their lending parameters and risk tolerance, mixing his own questions with others texted to him by the audience.

Jenkins patiently explained how an online investment platform like Fundrise differs from traditional lenders, responding to several questions on its minimum investments from accredited investors, its procedures for raising funds and acquiring real estate. The chief distinction he noted is that Fundrise investors do not take stakes in the underlying real estate, but rather in project payment-dependent notes backed by a trust.

In one regard, Jenkins said his firm has just as much in common with all other real estate investors.

"The internet didn't take the risk out of real estate," he said. "It may have changed the way we raise money for investment, but there are still a lot of (high risk) real estate deals out there. We all still have to do our due diligence to separate the good deals from the bad."

Guggenheim's Quinn and EagleBank's Marquez both noted the effect from increased competition in real estate lending, most notably narrowing margins and increased demands from borrowers. At the same time, increased regulation and risk management requirements in the banking sector are increasing their costs and reserve requirements.

"It's certainly not like the margins we were seeing a few years ago when fewer were doing real estate loans," noted Quinn.

Most lenders are focusing more on risk management in their lending, added Marquez. "For the right deal we will certainly be competitive, but we're always looking for ways to mitigate or hedge risk and protect our shareholders' lending capital." He cited a quote from a favorite movie, the Clint Eastwood World War II action-comedy Kelly's Heroes.

"There's a scene where the leader asks the tank commander why he has modified his tank to go faster in reverse. The tank commander tells them, 'We like to feel we can get out of trouble, quicker than we got into it.' That's a great answer, and I tell my lending people they need to be like that tank commander."

After a Horrific Weekend, How Will CRE, CMBS React?

By Erika Morphy, Globe St., November 16, 2015

WASHINGTON, DC—This weekend, it seemed, the world came apart. On Friday evening, three carefully-coordinated attacks by seven terrorists in Paris, France killed 129 people and injured 352. The country’s borders were closed and a manhunt initiated for one of the suspected perpetrators. A grim and heartbroken President Francois Hollande fiercely declared "We are at war." No one disagreed.

The attack on Paris was preceded by a less noticed double suicide attack in Beirut, Lebanon on  Thursday night, in which 41 people died and more than 200 were wounded.

The Islamic State took credit for both attacks. France retaliated on Sunday attacking Islamic State strongholds in Syria.

The ramficaitions from this weekend will continue to play out in the coming days, weeks, months and unfortunately, probably years as many experts see this assault on Paris as a geo-political game-changer.

What Will The Fed Do?

The terrorist attacks will just as surely affect the global economy as well.  More volatility is in store for the equity and bond markets and global Central Banks' monetary policy could well shift as well.  The US Federal Reserve Bank, for instance, cited global uncertainty as one of the reasons for not raising the benchmark federal funds rate at its September 2015 policy meeting. It was the first time in this real estate cycle that it had mentioned this risk.

After its October 2015 policy meeting, the Fed said that it was "monitoring global economic and financial developments," according to its Federal Open Market Committee statement. However it also said that -- indeed its lead sentence in the statement was -- "Information received since the Federal Open Market Committee met in September suggests that economic activity has been expanding at a moderate pace." That, plus a solid employment report for October had convinced most economists -- 97% of them, according to a Wall Street Journal survey -- that the Fed will begin to raise rates in December.

That survey was taken several days before the attacks, though. Now, it is a fair to speculate that, depending on the markets' reaction in the next few weeks, the Fed will hold off on raising rates at its next policy meeting.

Indeed, the global markets' reaction on Monday will be closely-watched by everyone, not just the Fed. One can certainly assume that there will be a sell-off and probably a sharp one similar to, if not worse than, the correction in August when it became clear that China's economy was softening.

It's possible, maybe even probably that the markets will return to normal within weeks or months. An interesting analysis in Bloomberg noted that over the past 15 years, global markets have become more resilient to the effects of world terrorist attacks. 

CMBS, Real Estate Valuations

For the commercial real estate market the more immediate concern is the commercial mortgage-backed securities market. As the events in August showed, the CMBS market is not immune to equity market volatility.

The past summer, John Levy, president of John B. Levy Co., a Richmond, VA-based commercial real estate investment bank, went to the CMBS market on behalf of a client to finance two properties. It was a routine deal and Levy received routine pricing. But before the transaction could close the equity markets went haywire over China -- and deal-making in the CMBS market completely stopped.

John Levy of John B. Levy Corp. found the CMBS markets shut in August after fears about China took hold.

"Nobody knew what they could sell these loans for," Levy said. "And lenders are not going to put a transaction on the books and hope to sell it when fair weather arrives. Lenders only close on transactions that they think they can find an immediate market to sell in."

Levy spoke with in October, several weeks before the attacks of this weekend.

But his experience is very applicable to what the environment for CMBS financing will probably be in the coming weeks. Performance in the equity markets is not directly linked to the CMBS market, but CMBS spreads are quoted against the swaps curve. So when the swaps market goes crazy, lenders are not inclined to price deals, or for that matter, follow through on commitments for deals that priced earlier.

CMBS market can and do volatile, Levy said -- and the trigger is usually larger US or global economic or macroeconomic events.

Another concern is that these events could be the precipitating factor to CRE asset pricing unraveling. There has been an uneasy sense brewing for some time that the property prices are inflated beyond their "true" value -- Fed Chair Janet Yellen said something like that in recent months; various industry surveys have also reflected this fear.

And unfortunately, with rates at near zero for so long, the Federal Reserve has no firepower should another crisis unfold.

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