The recent financial crisis and Great Recession may be nearly a decade behind us, but its echoes remain on the evidence of the uptick in mortgage borrowers failing to pay off maturing commercial property loans.
Payoff rates of maturing loans that back commercial mortgage-backed securities, or CMBS, fell for the third straight month to 64.9%, according to Morningstar Credit Ratings. About $3.3 billion, or roughly 35% of the maturing loans were delinquent, current but not paid off, or liquidated, as fewer retail and office loan borrowers were unable to obtain “take-out financing”–longer-term loans that replace shorter-dated financing.1
Looser loan underwriting criteria and higher loan-to-value ratios during the real estate boom fueled a frenzy of CMBS issuance. Newly-issued bonds peaked at about $230 billion in 2007, following about $202 billion in 2006. The volume of issuance of CMBS has tapered somewhat. Issuance reached nearly $76.0 billion in 2016, according to Commercial Mortgage Alert.2
These days, however, more loans originated at the height of the boom are coming due and borrowers are finding it difficult to refinance. Underwriting standards are more stringent than in the past and sectors of the property markets, like retail malls and shopping centers, are experiencing sharp declines in foot traffic, leading to store closings.
Taking the pulse of the U.S. property markets is yet another way to gauge the health of the economy. First quarter gross domestic product (GDP) rose to a 1.2% annualized pace in the first quarter, according to the Bureau of Economic Analysis (BEA).3
Investment in nonresidential structures like offices, malls and lodging now represents about 12.5% of U.S. GDP – only one percentage point lower than the recent high during the first quarter of 2008, according to the BEA.4
While investment in new office properties has picked up, real-estate firm Cushman & Wakefield notes that completions are roughly 25% lower than the run up to the financial crisis and about 50% lower than after the dotcom crash. Developers and landlords have been proactive in pre-leasing space or quickly filling new space as it comes on the market.5
Vacancy rates, however, are still at levels that favor renters over landlords. The national office vacancy rate has held steady for two straight quarters at 15.8%. Rental growth also has barely budged, with asking rents up by only 0.5% in the first quarter, according to Reis Inc.6
More About CMBS
Commercial mortgage-backed securities (CMBS) are backed by a pool of commercial mortgages. Borrowers’ interest and principal payments from the underlying loans are “passed through” to investors as income and offer attractive yields over Treasury securities, depending on the level of risk.
While the vast majority of these securities are sold to institutional investors like insurance companies and pension funds, a portion of CMBS does find its way into bond mutual funds. Exchange-traded CMBS products are also available.
1-“CMBS Surveillance Maturity Report,” Morningstar Credit Ratings: https://ratingagency.morningstar.com/PublicDocDisplay.aspx?i=LrkfG%2fqWqDA%3d&m=i0Pyc%2bx7qZZ4%2bsXnymazBA%3d%3d&s=LviRtUKXqs8kml5dHt7FTeE2SZmY0Fvqd4iX49Mk%2f9UapyiFTEO6TA%3d%3d (accessed June 22, 2017.)
2-Summary of CMBS Issuance, Commercial Mortgage Alert: https://www.cmalert.com/rankings.pl?Q=91 (accessed June 22, 2017).
3-U.S. Bureau of Economic Analysis: https://www.bea.gov/newsreleases/national/gdp/2017/pdf/gdp1q17_2nd.pdf (accessed June 22, 2017).
4-U.S. Bureau of Economic Analysis, Shares of gross domestic product: Gross private domestic investment: Fixed investment: Nonresidential [A008RE1Q156NBEA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/A008RE1Q156NBEA (accessed June 22, 2017).
5-“U.S. Macro Forecast: Measured Optimism Still on the Menu,” Cushman & Wakefield, May 2017: http://www.cushmanwakefield.com/en/research-and-insight/2017/us-macro-forecast/ (accessed June 22, 2017).
6- Reis Inc. office vacancy rates and rent growth: https://www.reis.com/hubfs/OfficeFirstGlanceQ12017.pdf?hsCtaTracking=bfd86c5b-f1bf-4698-8e2a-e60bf9ea8a52%7Cd6cee144-e34f-4eb3-9884-6af417d79f04 (accessed June 22, 2017).
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