In the last few days articles have appeared at Time, MSNBC and Fortune boasting about various aspects of a brewing commercial real estate recovery. John Reeder over at Marketwi.se warns us that this might be a reason to worry given the mainstream media’s track record of calling booms or busts at exactly the wrong times.
Time’s piece appeared first. It’s an interview with Mike Kirby, chairman of Green Street Advisors, that asks if commercial real estate is bouncing back.
This whole premise that commercial real estate is “the next shoe to drop” is overstated. Clearly, we have problems, since there are many mortgages out there that were underwritten using very aggressive assumptions, and those will be difficult to refinance. But the good news is, if you look at our property index, we’re back to 2005 pricing. So that means that most properties that were financed in ‘04 and ‘05 are not going to be much of a challenge to get refinanced. And, yes, the ‘06 and ‘07 deals, which some indices say are still underwater, will also need to be recapitalized. The good news is, there’s a very long line of capital sources that have shown up in the last nine months that are ready, willing and able to play that role.
Fortune’s piece came next, showing up yesterday afternoon. Its piece looked at how the CMBS market has exhibited some vitality lately (something we’ve noted as well). What’s been most remarkable about the CMBS recovery is that many people thought that the old model would have to be modified in some way for CMBS to come back. But that’s not been the case. Nor has the intervention of the federal government been as essential to the process as some had thought.
The piece is interesting and traces how the recovery of the CMBS sector has unfolded through a series of fortuitous occurrences, shifts in strategies and the emergence of buyers for bonds that previously may not have been so interested in the sector.
CMBS’s were in a complete freeze in 2008 and early 2009. They weren’t saved solely by government programs or a concerted “save CMBS” movement. Instead, a game of financial hot potato accomplished the necessary work of turning up the right buyers at the right times. Again, the prices weren’t always right — at one point, the “super-senior,” highest-rated tranches were trading at a paltry 50 cents on the dollar — but they reflected what people were willing to pay and represented a market nonetheless. That’s better than RMBS, CDS and CDOs could ask for at the height of the financial crisis.
The green signal that gave the go-ahead for investment activity was the government’s decision in March 2009 to open up TALF, the government’s toxic-asset buying plan, to CMBS. It soon followed by opening the PPIP plan to investors. Together, these two moves didn’t clean up many actual CMBS, but they did provide a go-ahead to many large institutional investors including hedge funds and money managers, who immediately started trading as much CMBS as they could.
The way CMBS investors worked out the market was a kind of compartmentalization. They drew sharp lines. Some investors maintained an interest in highly rated triple-A CMBS tranches, which were and are still considered mostly stable with relatively high yields of around 6%, higher than U.S. Treasury bonds. Others took an interest in the more speculative, more troubled “B-piece,” which carries with it lower ratings and greater chances of delinquency, but also provides the opportunity to push a loan into default and take control of the underlying real estate properties.
The CMBS market’s recovery, then, can be traced through the underlying shift in who was buying. Trying to judge who the real holders of CMBS are is challenging. Many values have dropped, which have caused banks and insurers to mark down the value of the holdings and therefore provide a skewed view of how much CMBS they might really own.
More recently this year, there has been another trend that has focused interest on legacy CMBS. Another group of buyers has stepped in: real estate investors looking to control the underlying properties by buying into the CMBS, helping to choose the “special servicer” that extends the loan, and influencing the way the loan modifications work.
The biggest play in the future might well be CMBS investors trying to get close to these special servicers.
MSNBC, meanwhile, posted a piece this morning saying that commercial real estate fundamentals have improved–but only in coastal markets. New York, Los Angeles, Seattle and Boston are mentioned.