The Wall Street Journal reported Wednesday that the financial engine of the market for office buildings, hotels and malls is showing signs of strain, raising questions about the resilience of the commercial real-estate boom.
Bonds backed by commercial-real-estate loans have weakened significantly since the start of the year amid concerns of an economic slowdown. Risk premiums on some slices of commercial-mortgage-backed securities have jumped 2.75 percentage points since Jan. 1, a move that translates into a roughly 18% drop in prices for triple-B-rated bonds, according to data from Deutsche Bank AG .
The sharp move could make it harder for buyers to keep paying ever-higher prices in a market regulators already caution could be overheating. It is also causing a lot of head scratching on Wall Street. Real-estate prices are at or near record highs in many parts of the U.S., and loan delinquency rates are low.
The sector doesn’t have much exposure to oil and energy companies, the focus of a lot of the recent market distress.
Yet investors in some cases are demanding to be paid as much to take on CMBS risk as they are to take on corporate junk bonds. Property owners and developers now are facing the prospect of higher rates on loans, tougher refinancings and diminished property values as debt issuance slows and financing becomes more expensive. Citing tighter financial conditions, Morgan Stanley analysts on Tuesday said they now expect no appreciation in the price of commercial real estate this year, “with risk to the downside.” They had earlier forecast gains of 5%.
Close to $200 billion in real-estate loans that have been bundled into securities are scheduled to mature this year and next, and most need to be refinanced, according to Trepp LLC, a real-estate data service.
“It’s not a good dynamic,” said Lea Overby, head of CMBS research at Nomura Securities. “The cost of financing will increase for borrowers with loans coming due.”
The $600 billion CMBS market accounts for around a quarter of all U.S. commercial-real-estate loans. Wall Street repackages loans made to finance apartments, hotels, shopping centers, and other developments into the securities and sells slices with varying levels of risk and return. The practice helps banks move loans off their balance sheets and frees up capital to fund new projects
The market is coming off a high point. Some $101 billion in CMBS were issued last year, the most since 2007, according to industry newsletter Commercial Mortgage Alert. Analysts who had earlier projected issuance to expand by up to 25% this year now are revising down their forecasts.
Billionaire investor George Soros’s family office has been a large seller, according to people familiar with the matter. A spokesman for Mr. Soros declined to comment.
BTG Pactual, a Brazilian investment bank that has been liquidating assets to shore up its liquidity, was also among the recent sellers of CMBS. Robert Pearsall, a BTG Pactual partner and its head of securitized products, said U.S. credit markets are signaling the economy could be headed for a rougher stretch than is evident in current data.
“If growth in general is slower than expected, it’s not hard to see why bonds backed by mortgages on retailers and hotels…might reprice wider,” he saidnoting that consumer spending hasn’t yet shown the big boost that was expected from falling oil prices.
ENLARGE Jeff Kronthal, co-managing partner at KLS Diversified Asset Management in New York, a fixed-income fund that invests in structured products, said the fundamentals of the real-estate industry are sound, but some hedge funds and investors that earlier bulked up on riskier securities have been liquidating their positions and pushing CMBS prices down.
CMBS with triple-B-minus credit ratings now yield close to eight percentage points above benchmark rates—a four-year high and a similar risk premium to corporate junk bonds, according to Morgan Stanley.
Traders said a key reason risk premiums on CMBS have taken off is Wall Street banks’ reluctance to hold securities on their books. Banks have to hold more capital against assets on their balance sheets, making them less willing to hold securities they can’t quickly sell. There also are fewer banks that now trade CMBS because some firms have exited the market.
Some $3.3 billion of CMBS were issued in January, the lowest monthly total since August 2012, according to Commercial Mortgage Alert.
The concern is that weakness in the financing market could hurt property values, which the Federal Reserve has warned were getting frothy.
Commercial-real-estate values are generally based on the income the properties generate and buyers’ borrowing costs. If investors and lenders pull back significantly, borrowers would have to put up more cash or equity, which could hurt property values, Trepp mortgage analyst Joe McBride said.
A national commercial-property price index from Moody’s Investors Service and RCA rose 12.7% in 2015 to an all-time high and is now 17.3% above its precrisis peak. Price gains slowed in the second half of last year, however.
Already there are signs that lending standards are loosening as borrowers try to keep up with rising values. Loan-to-value ratios have been creeping higher, and more borrowers are taking out interest-only loans.
“While loan underwriting has gotten more aggressive as the cycle has progressed, we do not see the type of extreme leverage levels in commercial real estate that we saw in the years leading up to 2008,” said Jim Higgins, managing member of Sorin Capital Management, an investment firm.
Write to Serena Ng at [email protected]
http://www.wsj.com/articles/warning-light-flashes-for-the-commercial-property-boom-1455618603
