In the commercial mortgage-backed securities world, conduit loans have always been the bread and butter of the market.
But while CMBS issuance has come roaring back this year after a rough 2020, conduit loan issuance — which involves long-term refinancing loans that get packaged with other loans, securitized and sold to investors — is still lagging.
Two other types of CMBS loans have accounted for the bulk of new issuance this year: commercial real estate collateralized loan obligations — or CRE CLOs — which are shorter-term bridge or transitional loans; and single-asset/single-borrower — SASB — loans, which are nine- and 10-digit loans for portfolios or trophy properties.
“When the sector that has historically been the issuance frontrunner starts running a distant third place, it leads the market to start asking questions,” Trepp analysts wrote in a recent report on the underperformance of the conduit sector.
In just the first half of 2021, according to the report, CRE CLO issuance has already broken the full-year record, reaching more than $20 billion. SASB loan volume hit $31 billion, more than all of 2020 and on track to exceed the pre-pandemic average.
In total, the private-label (i.e. excluding Fannie Mae, Freddie Mac and related entities) CMBS market produced $67 billion in loans through June, already surpassing the total for all of 2020.
Meanwhile, the first half saw just $14.7 billion in conduit loans issued, on track to match last year’s total of $28.5 billion, but still well below the average of $45 billion a year from 2017 to 2019. A look at which property types are getting CMBS loans helps explain much of the discrepancy.
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As the graphs above show, retail and lodging properties — among the biggest victims of the pandemic — have historically been major targets of CMBS lending, accounting for more than a third of total volume from 2017 to 2019.
The volume of hotel CMBS lending over the past 12 months is down 73 percent compared to the three-year pre-pandemic average. And if you exclude the $3 billion single-asset loan on Blackstone Group’s MGM Grand and Mandalay Bay in Las Vegas, which was originated before the pandemic but securitized later — following a few months of uncertainty — the decline grows to 89 percent.
“The challenge with hotels is knowing what cash flow one should underwrite” now that things are turning around, Trepp analysts wrote.
While lenders and investors may prefer that loan underwriting be based on performance over the past 12 months, including the dark days of the pandemic, borrowers would prefer to use a shorter time frame. As a result, few deals are getting done, and the ones that do have generally relied on pre-pandemic financials instead.
While the hotel sector can at least look forward to a rebound in the coming months, the picture for retail is more uncertain, given the headwinds malls and retailers were already facing before Covid.
“Broad-based lending on the traditional department store-anchored centers that have made up so much of CMBS retail, whether open-air or enclosed, does not seem to be on the horizon in a material way,” the report states.
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Meanwhile, Trepp analysts note that it is “somewhat surprising” that multifamily CMBS lending has not outperformed, given the strength of the sector. “The GSEs [government-sponsored enterprises like Fannie and Freddie] are likely just too competitive on price for conduits,” the report says.
In light of the conservative underwriting of some lenders, borrowers may simply prefer “to turn to a debt fund/CRE CLO lender for a short-term solution rather than lock in a less than ideal loan for the next decade.”
Finally, the one sector that has outperformed the market significantly is industrial and self-storage, spurred by growth in e-commerce and other disruptions. But this asset class “is just not a large enough or valuable enough sector on a per-square-foot basis to overcome the drop in retail and hotel,” in Trepp’s view.
Large industrial portfolios also tend to be more suitable for SASB deals, rather than conduits. The SASB market has recently produced several massive transactions, like a $4.65 billion loan for the 62,257-key Extended Stay America portfolio, or SL Green Realty’s $3 billion refinancing of One Vanderbilt office tower in Manhattan.
Trepp analysts also note that market sentiment, such as a “lack of desire to lock in long term financing in the current environment,” is leading many borrowers to extend their existing loans by another 12 to 18 months rather than seek new financing.
“Conduit CMBS is largely the underwriting of stabilized historical cash flow,” the report says. “Patience can be a virtue, especially when the loan you invest in today needs an asset that will stand the test of time (10 years plus).”