CMBS originations, commercial real estate debt fund activity and the fate of Fannie Mae and Freddie Mac were among subjects of discussion at MBA CREF 2019
In spite of a chaotic political environment at home and abroad and volatility in the stock market, debt capital should continue to flow freely into the commercial real estate space this year, according to panelists at the MBA CREF/Multifamily Housing Convention & Expo 2019 taking place in San Diego this week. Here are the takeaways from Monday’s sessions.
- Banks and life insurers are increasingly competing with CMBS lenders for the same loans, according to participants in the show’s “Capital Markets” panel. Three to four years ago, there was segmentation in the market in terms of which lenders would pursue which loans, according to Joe DeRoy, senior vice president in the capital markets group of KeyBank Real Estate Capital. “Over the last few years, those silos, those rings have all started to migrate together,” DeRoy noted. As a result, the volume of originations that CMBS lenders will be able to complete this year will depend partially on the willingness of banks to lend on class-B and –C assets in secondary and tertiary markets, CMBS’ bread-and-butter.
- In order to grow their share of the commercial debt marketplace, CMBS lenders may need to raise the leverage on their loans, according to both DeRoy and Chris LaBianca, managing director with UBS Investment Bank. There has to be some movement on underwriting for the CMBS lenders to attract more borrowers, LaBianca noted. “This is the first year since the credit crisis that [CMBS] market share has actually increased in size” relative to its competitors, LaBianca said. “There certainly seems to be an appetite for CMBS among fixed-income investors. If you raise the leverage, there’s room for that.”
- Raising loan-to-value (LTV) ratios on CMBS loans into the low 60 percent would be a viable way to grow the product’s market share without taking on too much risk and potentially losing interest on the investor side, according to DeRoy. In fact, “I, for one, would trade [higher] leverage for interest only [IO] loans,” he noted. The proliferation of IO CMBS loans has been a trend that had worried credit ratings agencies in 2018.
- Meanwhile, institutional and foreign capital continues to enter the real estate debt fund space, noted Jack Gay, managing director and global head of commercial real estate debt with Nuveen Real Estate, during a panel on “Debt Funds and the CRE Ecosystem.” “Some of it is just re-allocation from equity mandates into what is seen as a safer investment,” he said.
- In addition, intermediaries such as investment banks are increasingly marketing commercial real estate debt fund investments to their high-net-worth clients, according to Justin Guichard, managing director and co-portfolio manager with Oaktree Capital Management. That’s partly because there are still attractive returns and room to grow for debt funds that focus on core performing assets, Guichard noted. “Are we still able to get attractive deals with good sponsors and hit our return [targets]? Absolutely. There’s still room to grow. It’s a nascent market.”
- There is one product type the debt funds are largely staying away from, however, and that is retail real estate. Of the three panelists on the “Debt Funds and the CRE Ecosystem” panel, Guichard said that Oaktree has completed loans on grocery-anchored centers in strong markets, but those deals were in the minority, while Nuveen’s Jack Gay noted that “if we’ve done a retail deal in the debt space, it’s been one” deal, and he couldn’t remember what it was. For his part, Peter Sotoloff, chief investment officer and managing partner with Mack Real Estate Credit Strategies, said that Mack Real Estate had “no retail real estate exposure in our debt products. We saw these trends there were shocking and distressing,” and decided that even in the best case scenario, with well-capitalized assets, the risk was not worth it.
- While the debt fund panelists expect a downturn to occur at some point in the next three to five years, they don’t think it will be a severe one. In 2019, “we’re going to bump along,” according to Guichard. There’s more volatility in the market, “but no one is falling off a cliff.” Meanwhile, when the downturn does come, it won’t be deep, and “there will certainly be some distressed opportunities,” noted Jack Gay.
- The possibility of another downturn is also on the mind of Sandra Thompson, deputy director of the Federal Housing Finance Agency (FHFA), who participated in a panel on “The State of the GSEs.” Thompson noted that when she looks out her office window in Washington, D.C., she sees 10 construction cranes working on new projects, most of them multifamily and mixed-use. “We’ve seen this before, and we certainly want to be very cautious as we go forward,” she said. “We’ve been in this growth cycle for 10 years now, and I want to make sure that we’re taking a realistic look at things we may not necessarily know.”
- Asked about the possibility of the GSEs moving away from government conservatorship, Thompson said that “Certainly, I don’t think anyone expected the enterprises to be under conservatorship for over 10 years now.”
- When it comes to the rental apartment market, “it’s likely to continue growing at a faster rate” than the single-family space, according to David M. Brickman, president of Freddie Mac. “The over-arching issue is affordability,” he added, pointing out that the agencies are constrained in what they can do to drive more investment in the affordable housing market, which is obstructed by high land prices, high construction costs and zoning issues. “The issue we’ve wrestled with is what are the levers we actually have” to tackle the affordability crisis, noted Hugh R. Frater, interim CEO of Fannie Mae. “Our concern is that the supply of affordable units hasn’t changed.”
- Both Brickman and Frater also said that while property fundamentals in the rental apartment space should continue to perform well over the coming years, pricing on those assets has become a concern. “It’s late in the cycle, a little more caution is warranted. The growth we had in the past probably can’t be replicated,” according to Brickman.
- Frater also worries about the impact Opportunity Zones legislation might have on property values. “People almost don’t care about the price as long as they don’t have to pay taxes,” he said. “My concern is ‘will it distort the pricing?’”
- As the commercial real estate industry tackles the trend of office tenants moving toward flexible space and co-working, this year’s line-up of panels also featured one on “The Evolving Workplace.” According to speaker Scott Marshall, president and chief development officer of CBRE wholly-owned subsidiary Hana, CBRE researchers found that office buildings that have up to 30 percent of their rent roll dedicated to flexible space tend to sell at slightly lower cap rates than traditional office buildings. However, once the percentage of the building’s rent roll that comes from flexible space goes up to 40 percent or higher, cap rates tend to move above those of traditional buildings. “We actually think [flexible space] needs to be less than 30 percent of the rent roll,” Marshall noted.