Outlook for the CMBS Market
Investor demand, coupled with expected continued government bond buying, is fueling optimism of increasing growth for CMBS next year.
Quarter-End Insights
- Investor demand for CMBS persists, but macroeconomic uncertainty could quickly change market dynamics and derail improving CMBS fundamentals.
- Different commercial real estate sectors may experience different economic pressures within the same environment.
- The CMBS delinquency rate has decreased from one-year prior, and the dollar amount of delinquencies should trend in a favorable direction if investor demand remains high.
Many observers of the CMBS market are asking the question, "What can I expect in 2013?" The industry consensus appears to answer this question with a resounding "better than 2012." In the closing months of 2012, CMBS deals were well oversubscribed, and commercial mortgage-backed securities priced in the past month have sold at or near the tightest yield spread premiums since 2007, confirming investor demand in the wake of increased supply. This investor demand, coupled with the expected continued government bond buying, is fueling optimism of increasing growth from 2012's more than $40 billion of issuance to a possible $50 billion-$75 billion next year.
Even though many in the market are optimistic, there is macroeconomic uncertainty that could quickly change market dynamics and derail the improving CMBS fundamentals. If the EU debt crisis flares or the fiscal cliff comes to fruition, widening spreads and lowering new issuance profitability could stifle the market. Also, components of the ongoing Dodd-Frank legislation could cause the reduction of investor demand, especially for B-piece buyers.
Commercial real estate tends to lag the overall economy, but different sectors may experience different economic pressures within the same environment.
Office Sector: Employer demand and supply of office space are the key drivers of the office sector. The demand for office space has been suppressed by high unemployment and the increased telecommuting of employees, both trends we believe will continue. Since the development of new office space can take years to come to market, there is a risk that newly built supply will outpace demand even though unemployment is expected to slowly improve.
Retail Sector: The retail sector is made up of traditional bricks-and-mortar stores to secure CMBS loans. The traffic to retail stores has been reduced by increasing e-commerce, a trend we expect to continue. Additionally, we expect that unemployment shall remain at elevated levels and discretionary spending shall remain low next year, limiting shopper demand. These risk factors will continue to put pressure on retailers and negatively affect retail property performance.
Multifamily Sector: The multifamily sector was the first type of commercial property to recover from the meltdown in 2007. The weak residential housing market led to increased foreclosures, and a large number of people seeking new housing. One of their options, if not their only option, is to move into rental housing provided by multifamily apartment units, increasing the demand for this property type. We expect that the weak housing market will continue providing for high demand of multifamily properties.
The CMBS delinquency rate reached 9.05% through November, which is a 0.37% decrease from one year prior. The dollar amount delinquent was $53.76 billion, which is a $6 billion year-over-year change from 2011. We expect the dollar amount to trend in a favorable direction, but this assumption is predicated upon the CMBS market demand and special servicers' actions to resolve delinquency. If investor demand remains high and spreads remain tight, the lenders will be able pass on the cost savings to borrowers. This will facilitate more liberal underwriting and financially beneficial mortgage terms to borrowers. Additionally, the majority of the outstanding loans were originated between 2004 and 2007, many of which will have balloon payments over the next four years. If CMBS investor demand remains high, there will be increased probability that refinancing into another loan will be available. If the financing is not available, the ability of the special servicer to extend maturity or modify the mortgage terms will dictate performance.
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