By Julia Nachman ’11 and Stephen McGuire ’11
David Sherman ’82, president of Metropolitan Real Estate Equity Management, moderated a panel discussion with John Brayshaw, principal at Prime Finance, Mark Finerman, managing principal at Loan Core Capital Partners, and Spencer Haber, CEO of H/2 Capital Partners on the state of commercial real estate debt markets.
Because “distress” frequently arises in discussions about commercial real estate debt, the panel began with a conversation about whether there is, in fact, distress in the system, and how to define distress. While all three panelists agreed there is distress in the system, each had a unique view on how distress is defined.
Haber commented on realized losses from both the equity and mezzanine perspective and remarked that the market will focus on “rescue finance” for the next two to three years. Finerman defined distress as the inability to finance one’s way out of trouble. Brayshaw remarked on the high percentage of senior CMBS loans in special servicing (over 13 percent), and of underwater deals on commercial bank and life company balance sheets.
The dialogue then turned to availability of liquidity. The panelists agreed that commercial real estate lending today has a “have and have-not” element to it. While liquidity is plentiful for deals that fall within what the panelists referred to as “the box,” it is scarce for more challenging transactions. However, because lenders are risk-averse and only looking to lend on properties with low loan-to-value and high debt coverage ratios, Finerman emphasized there are opportunities available to lenders with the ability to “peel back the layers of the onion” and look at properties with below-market rents, rollover, or vacancy, whose underperformance is attributable to broken capital structures rather than poor asset quality.
However, whereas he only looks at large assets in big, 24/7 cities as a way to mitigate losses, Brayshaw believes the opportunities in today’s market are in secondary and tertiary markets where peak to trough fluctuations are not as significant.
Next, the panel’s attention turned to the future of the CMBS market. Haber noted that the $1.3 trillion of commercial real estate debt maturing in the next few years is a gross multiple of available capital. He also discussed the reemergence of competition amongst banks for loans that can be securitized, noting that six or seven big banks have mandated a strong push back into the CMBS arena.
When discussing how CMBS deals will be structured, the panelists agreed that while currently there seems to be at least an attempt to recall that the “world almost ended,” and there are some attempts to remedy the misalignment of interests amongst different tranches of investors by amending voting and control rights, in effect, new CMBS will be strikingly similar to old CMBS.
In terms of demand, Haber noted that there is a lot of demand in the bond market, but it is largely the result of a flight to safety, with investors seeking securities that offer yield, current payments, and liquidity. Because the search for yield is largely driving the demand for bonds, the panel’s attention then turned to what will happen to the market once the Fed raises rates. Finerman emphasized the importance of relative value; while investors may have an appetite for mortgage debt, it is important to take risk into consideration when measuring performance.
Lastly, the panelists addressed a question regarding opportunities in FDIC auctions. Haber stated that, unlike when the RTC auctioned off many high-quality assets, there is a direct correlation between failed banks and the quality of loans on the banks’ books. Therefore, he sees limited opportunities until the supply of bad loans on better quality properties increases in 2011 and 2012. Mr. Finerman also expressed hesitation relating to FDIC auctions because valuations are so uncertain and the cost of diligence as a percentage of the purchase price is so high.
Overall, the panelists were in agreement that plenty of opportunities exist in commercial real estate debt for investors who have the patience and capabilities to think creatively.