- James I. Clark III
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QE3 A Boon to CMBS
If history repeats itself, QE3 will be good for commercial mortgage-backed securities (CMBS). The Fed’s third round of quantitative easing – which is purchasing $40 billion of residential mortgage-backed securities (RMBS) each month from Fannie Mae and Freddie Mac – will free up money for the commercial real estate market and lure investors away from other vehicles in their hunt for maximum yield. QE3 is expected to last at least until 2015.
“The primary difference between 2012 and 2010 is that commercial property prices in healthy markets are stronger than they were just two years ago. At its peak, CMBS constituted 40 percent of all commercial real estate loans,” said John O’Callahan of CoStar. O’Callahan notes that “Investment returns of 40 percent or more for riskier assets during QE1 were largely a result of a bounce-back from the lows caused by investor panic in late 2008 through early 2009. The overall impact of QE becomes clearer upon examining QE2. Prices of equities and high-yield bonds, including CMBS, gained a respectable 12 to 15 percent.”
Low interest rates mean that returns will narrow to as little as 150 basis points, forcing investors to look elsewhere for respectable yields. Currently, B-piece CMBS investors are achieving 20 percent and higher yields. By contrast, the Dow Jones Industrial Average’s yield has remained below three percent each of the last 20 years.
CMBS has “been a boon for us,” said Kenneth Cohen, head of CMBS at UBS Securities. “You’ve seen a fairly good size increase in loan pipelines. Our pipeline has increased probably 50 percent over the last six weeks.” Borrowers also are cashing in on the favorable loan terms. According to Fitch Ratings, loans in 2012 are averaging 95.7 percent of a stressed property’s estimated value; that’s up from 91.6 percent in 2011.
Despite the good news, industry experts don’t expect the resurgent CMBS market to resolve all financing woes. For example, the encouraging loan terms are of minimal help to commercial real estate owners who are under water, nor will new issuance be adequate to refinance the $54 billion in CMBS loans coming due this year. Additionally, some ratings firms warn that the credit quality of CMBS loans could increase risk for some investors. In response, Moody’s Investor Services’ now requires that senior bonds have expensive credit protection.