In his column on Monday, Paul Jackson presented his take on the likely double dip in the US housing market. This turned my attention to the usual suspect, often one step behind the residential market: commercial real estate. But whether CRE will follow suit, as the market thought was customary, is an issue of great debate, I found. Since last week's InsideOut, which discussed what the first residential mortgage backed securitization (RMBS) would look like, the first true CMBS jumped the gun and hit the market, care of the Royal Bank of Scotland. Has the student become the master? Hard to say. RBS won't comment as the deal is a private placement, but thankfully Barclays Capital did. The $310m RBSCF 2010-MB1 deal, met with strong demand – pricing tighter than initial expectations. Dan Gorczycki, a managing director of global real estate service provider Savills US, said of the deal that "there are certain shops inventorying ten year loans at 6.5%, and they hope to copy RBS with low leverage, great yields, etc. But what happens when ten of these come to market?" "So the investment banks are betting that bond buyers will soak up the supply. However, the markets are correlated in a number of ways and I'd be hard pressed to see residential markets going down and commercial markets going up. In addition, if the residential market double dips, weaker consumer spending could adversely affect retail sales -- and thus the performance of malls and power centers -- and employment is directly correlated with vacancy rates in office buildings." But the good news keeps coming. BarCap analysts also said CMBS continued to deliver strong absolute and relative returns in March. It was the fourth consecutive month of positive excess returns for the investment grade CMBS Index. And, further, this came from Moody's Investors Service yesterday:
Commercial real estate markets across the U.S. continued to show signs of improvement. The supply pipeline of new properties continued to shrink across almost all sectors while projected demand improved.
"This quarter's numbers maintained the positive theme that began last quarter," says Moody's senior analyst Keith Banhazl. "While vacancy rates remain high, generally due to the poor absorption experienced in 2009, projections show a slowdown in negative absorption over the next year." Moody's also put CMBS delinquencies at 6.42% today and Deutsche Bank says it's now over the 7% mark. These number play well in the press, but don't really equal the reality facing CRE, nor does the Moody's claim above it. While, it is becoming commonplace to hear that CRE is straightening itself out, the truly alarming thing is that banks are listening to this…. When they really, really shouldn't be. CRE loans are expected to remain highly elevated for several years. And, according to a research report from Deutsche Bank, "That banks could already be through most of their CRE-related problems is extremely unlikely, in our view. That banks are now reserving less for future CRE losses is worrisome." Lisa Pendergast, managing director of CMBS Strategy & Risk at investment banking group Jefferies and president-elect of the CRE Finance Council, said losses are still projected in the market as "in many cases the borrower will have to fill the equity gap and with $100m properties now worth $60m, they may realize that the market is not going to greatly shift in the next two years and just exit out." "Currently the bid-ask spread between where buyers want to buy and sellers want to sell is fairly large. Yet, our indicators suggest the bid-ask has begun to contract in 2010 and will continue, which will be positive," she added. "The contraction in the bid-ask will be hastened by the increased sources of liquidity as a number of conduit lenders are prepared to lend." And who wouldn't agree with someone of the pedigree and scope of knowledge as Pendergast? But as Gorczycki told me, the market is a double-edged sword. CMBS legal extend maturities are normally capped at two years. The pretend and extend strategy of banks is showing that these deals are willing to skirt the law a bit if it means keeping the market from collapse. But with so much debt coming up for refinance. And with CRE firms running to brokers for liquidity (who are the going to call otherwise? Lehman? Capmark?) the demand for acquisition finance will certainly exceed capacity this year. And that's the moment the double-edge sword turns into a double-dip.