Commercial-Mortgage Market Gets Frothy

Posted on November 30, 2012

Earlier this year, it looked as if the owner of Las Vegas’s Fashion Outlets mall was facing a problem: Its $107 million in debt was nearing maturity, and the credit markets weren’t strong enough to refinance that entire amount.

But since then, the real-estate finance market has gotten a lot rosier. The 376,000-square-foot mall’s owner, AWE Talisman, was able to borrow $32 million of junior, or “mezzanine,” debt and another $73 million of senior debt that was packaged into commercial mortgage-backed securities at attractive terms.

“We’re seeing deals that we thought wouldn’t be able to refinance, actually refinance,” said Darrell Wheeler, head of commercial-mortgage bond strategy at Amherst Securities Group.

Strong investor demand for yield in a low-interest rate world has unleashed a lending boom in commercial mortgages, producing the most favorable conditions for borrowers since 2008. The commercial-mortgage bond market, which all but died in the years following the financial crisis, is expected to see $46 billion of new issues in 2012 and as much as $65 billion in 2013.

At the same time, the market in recent months has seen a growing availability of mezzanine debt, which had been even-rarer to find than CMBS. While the total volume of mezzanine debt issued isn’t tracked, it has been a component in several high-profile deals in recent weeks, including the refinancing of the Extended Stay America hotel chain.

This lending surge is raising concern among some analysts, who warn that underwriting standards already have started to suffer. According to an analysis byMoody’s Investors Service, MCO +0.14% the leverage put on properties in recent commercial-mortgage securities deals is about 20% more than in borrowings in the middle of 2010, when that market came back to life.

“Leverage is moving in the wrong direction,” said Tad Philipp, Moody’s head of commercial real-estate research.

But the greater availability of financing also has given a much-needed infusion of capital to property owners. They are putting more debt on their buildings and doing so at lower rates and at more lenient terms.

The rate on recent issues of commercial mortgage-backed securities has been as low as 0.83 percentage point above interest-rate swaps, the lowest since 2007 and down from 1.6 points at the start of 2012.

Some owners are taking cash out of their properties. For example, the owners of Extended Stay—Centerbridge Partners, Paulson & Co. and Blackstone Group BX +0.11% —plan to borrow $3.5 billion by selling a combination of commercial-mortgage securities and mezzanine debt. They would put about $700 million of the proceeds in their pocket and use the rest to replace existing debt.

Other owners are finding it easier to refinance than at any time since 2008, according to Trepp, a commercial-mortgage bond data provider. The number of loans refinanced at their maturity date was an “elevated” 61% in October, compared with the 12-month average of 44%, the firm said.

Refinancing was a major concern in the market one year ago, as investors faced $41 billion of commercial-mortgage securities set to mature in 2012 and $30 billion in 2013. But thanks to the looser credit, the market hasn’t seen the sharp rise in defaults, foreclosures and other headaches that was feared.

In one recent deal, Cerberus Capital Management took a major step toward shoring up the balance sheet of a portfolio of resort hotels in Hawaii and San Francisco with a $1.8 billion loan from Goldman Sachs Group Inc. GS -0.76% The debt included a senior mortgage and several mezzanine loans, according to people briefed on the transaction.

Property owners have been able to boost borrowing partly because commercial real-estate values have increased in many areas. As a result, some have been able to raise their mortgages but still maintain the same so-called “loan-to-value” ratio, between the amount of the debt and the value of the property.

But, in other cases, the expansion of mezzanine debt is taking loan-to-value ratios to new heights. In the Fashion Outlets of Las Vegas refinancing, the debt level increased to 84% of the property’s value from 58.4%, according to a term sheet for the commercial mortgage-backed securities containing the loan. AWE Talisman, which put $4.6 million of equity into the Las Vegas deal, didn’t respond to calls requesting comment.

Al Yoon, Wall Street Journal