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Trillion Dollars Here, Trillion There, Pretty Soon You’re Talking Real Money!

Posted by Larry Doyle on April 23, 2009 5:09 PM |

The commercial mortgage market has been around a long time; the commercial mortgage-backed securities (CMBS) market has only been around for little more than a decade.  The growth of the CMBS market, in which the actual mortgages are pooled and securitized, has been significant in that it brought new pools of capital into the commercial real estate market. 

Not unlike the residential mortgage market or the corporate loan market, the commercial mortgage market performed fine as long as the underwriting process maintained the necessary discipline. Much like other sectors, however, the commercial mortgage market is now sufferring as lax underwriting standards are catching up with it. Who wrote these loans with lax underwriting standards? Wall Street banks. These banks launched mortgage conduits which originated commercial mortgages for purposes of pooling and selling via the securitization market. 

Friends of mine in the commercial real estate market have advised me of very aggressive pricing of many loans along with shoddy underwriting. As a large percentage of those loans are now approaching a refinancing date, the prospects of refinancing are challenging.  In turn, the likelihood of rising defaults are increasing.

Bloomberg highlights a Deutsche Bank report in which Commercial-Mortgage Crunch May Reach $1 Trillion  over the next decade. The property owners will certainly have to inject more capital into commercial properties in order to maintain a loan to value ratio necessary for refinancing. If the owners do not have that capital, the banks can extend the maturity, or the mortgage can default. 

The bulk of the problems in the commercial real estate sector center on properties purchased over the last two to three years at the top of the market.  Bloomberg shed further light on this mess:

Many commercial real-estate borrowers will be unwilling or unable to put additional equity into the properties, and will have to negotiate to extend the loan or walk away from the property, the analysts said. The volume of potentially troubled loans and declining real-estate values will make loan extensions harder to obtain.

“The scale of this issue is virtually unprecedented in commercial real estate, and its impact is likely to dominate the industry for the better part of a decade,” the analysts said.

Many dismiss the seriousness of the problem by assuming lenders will agree to extend maturities, according to the report. That approach might work if the amount of loans that failed to refinance was relatively small, but the percentage is likely to be 60 to 70 percent, the analysts said.

The overhang of distressed real estate will hinder price appreciation, making lenders less likely to extend mortgages with the expectation that the value of the property will rise enough to qualify for refinancing, the analysts said.

Loans made in 2007 when prices peaked and underwriting standards bottomed will face the biggest hurdles to refinancing. Roughly 80 percent of commercial mortgages packaged into bonds in 2007 wouldn’t qualify for refinancing, according to Deutsche data.

There seems little doubt that there will be some great deals to be had in the commercial real estate sector. While one can be patient, it is also critically important to work with proven professionals in this space as there are a lot of moving parts in virtually every deal.


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