Real Estate Forum - October 2011

ness with billions of dollars worth of funding capability.

But the downgrade of US debt threw the CMBS market into turmoil. As mentioned earlier, S&P withdrew its rating on a $1.5-bil- lion CMBS sale by Goldman Sachs and Citigroup. Activity slowed, spreads widened and projections of $75 billion in 2011 originations were quietly shelved.

“The CMBS market seemed be roaring back at the beginning
and spring of this year but that has ground to a halt,” says Jim
Sullivan, managing director at Newport Beach, CA-based Green
Street Advisors. “By this point we had expected it to be robust, but
liquidity for secondary locations and second-tier quality assets has
all but exited the market.”
“Clearly CMBS is taking a breather in trying to figure things
out,” says John Pelusi, vice chairman and CEO of HFF. “Instead of
quotes coming in with a five handle, they are coming in with a six
handle. And they are less aggressive with the proceeds, which is
creating a hole in the capital structure.”
However, this hiatus appears to be temporary, not like the radio
silence that met the industry in 2009, when the transaction count
barely reached into the double digits of billions of dollars.

The Goldman Sachs CMBS deal came back to the market struc-
tured with a super-senior tranche. Super seniors made their reap-
pearance this summer, days after the downgrade of US credit, in
fact. Deutsche Bank and UBS brought to market a security with a
30% subordination level structured in it. The Goldman Sachs
transaction marks the third super-senior CMBS since the crash,
prompting some in the industry to label these deals “CMBS 3.0.”
The super-senior structure could prove to be a saving grace for
the CMBS market for the remainder of this year, Green Street’s
Sullivan acknowledges, but they’re not likely to be the only solu-
tion. More probable, he says, is that the market will see a mix of

approaches: some deals will carve out super-senior tranches, while other players will partner to better diversify the risk or otherwise fill gaps in their platforms, along the lines of what Prudential and Barclays are doing.

Ditto for the B-piece buyers, says Gerard Sansosti, executive managing director in HFF’s Pittsburgh office. CMBS cannot grow beyond a certain volume, even in the best of circumstances, without a wider pool of B-piece buyers, he notes.

The number of players tends to fluctuate every quarter, at least since the emergence of CMBS 2.0. This year, there has been between five and seven active B-piece buyers. The cause is not lost for the B piece, though, since—and this is a common refrain for much of commercial real estate—the yield is better than what other investments offer, Sansosti says. “Obviously when pricing is between 375 and 400 bps, there is better opportunity to get yield in the B piece,” he states.

When the CMBS market went haywire in August, any deals that didn’t close were re-traded. “They were repriced and the borrower didn’t know what they would price at until just before closing,” says Sansosti. He thinks such volatility will continue, with borrowers having to wonder up until the last minute about the spread they will be paying.

“So far this year I would estimate there has been $20 billion in
CMBS, with another $10 billion that is committed,” Sansosti says.
“For these reasons I don’t think we will see much more than $30
billion in CMBS originate this year.”
For originators, though, “the CMBS market makes abundant
sense,” Sullivan says. “What has happened is that originators got too
aggressive yet again and investors hit the brakes. Now the originators
will have to figure out what works in this current environment, not
just in terms of risk and underwriting but also in terms of price.”

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