Commercial Mortgage-Backed Securities Rise as Investors Grow Weary

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Street of residential houses
The recent rise of commercial mortgage-backed securities has stimulated the property market and left lenders and borrowers content. However, some financial analysts believe there is cause for concern.

The Wall Street Journal reports that in 2014, real estate lenders made approximately $94 billion in loans that were repackaged to investors as bonds. According to Commercial Mortgage Alert, that is the highest amount of this kind of bond sold since 2007.

These bonds, which are known as commercial mortgage-backed securities (CMBS), are predicted to rise even further for the rest of the year. A recent survey conducted by the trade group CRE Finance Council reports that 88% of participants predict lenders will make at least $100 billion in CMBS loans this year, while 18% of respondents believe that figure will actually grow to more than $125 billion.

Commercial mortgage-backed securities are a prominent yet protean feature of the larger commercial-property lending market. They tend to do very well when times in Wall Street are good. As long as there is a demand for CMBS by investors, lenders and banks are more than happy to issue them sans fuss.

However, some lenders and financial analysts are worried that these massive issuances might saturate the real estate market and could even fall apart, especially given the state of the economic recession. Still, these issuances are no where near the $229 billion worth of CMBS accounted for in 2007.

The main reason why CMBS are in high demand is because of their lucrative yields. Commercial mortgage-backed securities typically have interest rates between 4 and 5% for ten-year bonds. This is in stark contrast with other financial investments such as corporate bonds and 10-year “Treasurys,” which carry interest rates of 2% or lower.

“There’s a paucity of other comparatively attractive products to buy,” said Edward Shugrue, CEO of Talmage LLC, a real estate investment company. “It’s harder to find attractive yields.”

“Money is more readily available,” said Eric Blumenfeld, a real estate developer. “And for performing assets that have cash flow, there’s a lot of different options.”

The high demand for CMBS has lead to an increase of lenders that offer them. In 2014, there were approximately 35 active lenders that issued CMBS, nearly double the amount of such lenders in 2011.

Though the benefits of lenders issuing CMBS are high, the increased competition over issuances have many financial analysts and insiders predicting that lenders will take on lower-quality and riskier loans to compensate. In a recent survey of financial experts, 82% of participants expect credit quality to be lower in 2015 than it was in 2014.

Tad Philipp, director of commercial real estate research at Moody’s Investors Service, is openly concerned about the trend of issuing CMBS as well as riskier loans. If not checked, he said, the market could face serious repercussions.

“We’re heading in a bad direction,” Philipp said. “There’s no one increase that’s alarming…the trend and the consequences are concerning.”

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