Newark, DE, August 13, 2007 - Volatility in the credit markets continued across the board this past week due to the ongoing sub-prime woes and worldwide credit liquidity issues. As a result, CMBS (Commercial Mortgage Backed Securities) spreads widened dramatically over the last couple of months, and, in particular, over the last few weeks.
Commercial Mortgage Backed Securities (CMBS) are derived from pools of commercial real estate loans. The securities are sliced and diced into multiple tranches. Recently, increased levels of subordination (the highest risk tranche that is the first to absorb losses) have been required by both the rating agencies and the AAA buyers and therefore overall yields climbed. However, AAA buyers are also demanding enhanced spreads. In addition, many bond investors seem to be fleeing to Treasuries as a “safe haven” and therefore liquidity is drying up and the remaining investors can easily demand greater yields.
Fortunately, treasuries have trended down recently helping offset some of the spread “pain.” Underwriting standards have tightened dramatically over the last couple of months and gone are the days of 10-year interest only periods and underwriting to projected cash flow. Real estate investors should tread cautiously over the next few months as only the better quality deals that are priced right and underwritten to normal parameters will be financeable in the CMBS space. In fact, some CMBS lenders have closed shop, at least for now, as the market is too unpredictable and they’re unwilling to absorb losses for loans that are priced incorrectly.
Alternatively, borrowers should consider other forms of financing. Balance sheet lenders offer a viable alternative now that benchmark spreads for CMBS financing are in the 200 basis points over range. Further, those financing with balance sheet lenders will obtain a more flexible structure compared to CMBS structures. Credit market volatility will likely remain for some period of time and only highly experienced borrowers, or those with advisors with strong and deep experience in the world of commercial real estate finance, should attempt to navigate on their own.
