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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   June 2017

Choose Your Financing Options Wisely

To counter CMBS market uncertainty, you have to cultivate other funding options

Issuance of commercial mortgage-backed securities (CMBS) in 2016 declined year over year for the first time since bottoming out in 2009, in the wake of the recession. This can be primarily attributed not to the volume of commercial transactions seeking funding, but to the risk-retention requirements that took effect late last year. With CMBS issuers aware that structured deals would require them to retain at least 5 percent of every deal, some lenders hesitated to re-enter the market, or attempted to find other ways to grow their portfolios.

A key question: Will issuance of new CMBS deals be sufficient to refinance the wave of performing CMBS loans that mature in 2017, as well as fund new deals? Some $90 billion in CMBS loans are expected to mature this year, and Morningstar Credit Ratings projects that some 60 percent will be eligible for refinancing. 

Most projections for total CMBS issuance in 2017 range between $65 billion and $70 billion. This suggests that only $10 billion to $20 billion of new assets will find funding in the market this year, assuming the balance of CMBS issuance is directed to refinancing. What does this imply for lenders who fund loans through CMBS securitization? How will nontraditional products be impacted by this tight market? How will your clients react?

These are important questions for lenders as well as commercial mortgage brokers who serve clients seeking financing that is linked to the CMBS market, and the answers are not easy. Many first- and second-tier lenders use securitization as their primary (and in some cases only) means to fund portfolio growth. Other lenders have been down this road before and know they need staying power to ride out the cyclicality of the CMBS market.

Changing dynamics

When the CMBS market peaked in 2007, with over $230 billon in CMBS issued, many lenders thought they had found a free-flowing tap of cash. Within one year the financial crisis hit and many found out how untrue that was. In 2008, the bottom dropped out of the market and issuance fell by more than 90 percent — and then dipped even lower the following year.

As many remember, this caused the market to seize and many lenders to disappear. This left commercial mortgage brokers with deals in limbo and unhappy clients. Fortunately, the strong survived by self-funding, downsizing or finding alternative ways to fund new originations. Now, as the market heats up and CMBS issuers begin to return, every broker needs to make sure their prospective lenders can fund the current deal and that they also will be there to fund the next one.

In addition to buyer demand and maturity issues, expect additional stress to be placed on the CMBS market as the product mix shifts from retail to industrial and logistic facilities. In that light, how strong will the appetite be for refinancing CMBS deals backed by retail space that were underwritten with prerecession cash-flow assumptions?

Brokers working with these clients will need to be intimately involved in their client’s refinance process. Updated cash-flow models and pricing will be required to find new funding for performing legacy assets that have matured. This may mean moving from a CMBS environment to a portfolio lender.

Making choices

It is the broker’s job to guide their client to the proper lender. It also is the broker’s job to explain the options to both the borrower and the current lender. Brokers may need to seek discounted payoffs of the maturing loans, which today represent 100 percent of market value, in order to refinance. They may need to guide a commercial property owner through a short sale or propose a deed in lieu of foreclosure, if the current lender is not being flexible. All options need to be on the table as owners and brokers work together to refinance maturing CMBS assets in the 2017 environment.

For new buyers of commercial real estate, there are lessons to be learned from the issues facing today’s CMBS market. Does a property owner want their deal funded in a market that is so turbulent? Is the cost difference that often exists between a portfolio lender’s deal and that of a securitizer worth paying in exchange for the financing stability and peace of mind?

If the lender you are working with relies on the small-balance CMBS market to fund their transactions, you may need to be worried.

These are questions that you as the professional advisor need to help your client address. The evaluation of different rates and terms is complicated. It is up to you, as the broker, to present and explain all available options. To best serve you client’s interests, you need to have a full array of lenders in your quiver. You need to know how each lender you work with funds their transactions and how they fund their portfolio. It’s also important that you and your client weigh the terms each lender offers.

Because many CMBS transactions are structured on a 10-year maturity, you will be tasked with anticipating what market conditions will be like in the future. Will market conditions be like today, or even tougher? Will your client’s property type be out of favor like some retail properties are today? Where will interest rates be?

These are all important issues that commercial property owners who have maturing CMBS transactions are facing. Do you want your client in this position? As the professional advisor to the commercial property owner, your job is to help that client consider these various sources of risk so they can make the best possible decision.

Lender diversification

It’s very important for a broker to understand how each lender they work with accesses capital. There are a whole variety of lenders out there, including life insurance companies, banks and their subsidiaries, as well as private lenders, all of whom fund their own portfolios. Alternatively, there are lenders who ultimately securitize their assets.

All of these players serve a purpose. All have attractive products. The challenge is matching your borrowers, their property types and their transaction sizes with the right funding source. Your client’s appetite for risk — both with regard to rate and maturity — plays into this selection process. It is often best to present your client with a variety of offers from a variety of lenders. A detailed explanation of the pros and cons of multiple offers will provide you with the chance to showcase your experience by explaining the differences — not only in loan terms, but also between lenders.

For those brokers involved in small-balance commercial real estate deals, or deals that don’t fit a conventional underwriting model, the tightness in the CMBS market presents even greater challenges. Facing limited dollars flowing into the CMBS market and risk-retention requirements, issuers and purchasers of the underlying bonds are still just testing the waters for CMBS secured by these less-conventional transactions. The few small-balance deals that have come to market have received a mixed reception.

If the lender you are working with relies on the small-balance CMBS market to fund their transactions, you may need to be worried. As the market has demonstrated, these lenders are sometimes forced to change underwriting standards on a dime. If the bond underwriters for a lender’s deals don’t like a policy, the lender is forced to make a change that affects every deal in process. Your customer can easily get caught in the switches. When that happens, they may very well blame you. This is why understanding each lender’s ultimate funding methodology is critical.

•  •  •

Strive to work with lenders who have internal-funding strength and retain all their loans, as well as with lenders that securitize. Doing business with a combination of lenders will let you deliver the best service for your customer and thus maximize your earnings.  


 


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