The blogosphere is abuzz with the news big commercial real estate owners want newly originated AAA CMBS paper to be eligible for purchase through the Term Asset-Backed Securities Loan Facility (see posts from Housing Wire, Clusterstock, Market Movers, and Calculated Risk. You can read the actual request here). Everyone is framing this as a bailout, but I think they’re missing what’s really going on.
The request talks about the large volume of CRE loans which are maturing, and the fact that the traditional sources that would ordinarily refinance these loans are out of the market. That’s true, but it doesn’t matter. If you have a good, performing CRE loan which matures and the lender or servicer is not willing to extend at a market rate, a bankruptcy judge will be happy to help. A simple extension at a market rate to protect real equity is about as straightforward a Chapter 11 plan as you can get. Yes, it would be nice if you didn’t need to go to court to refinance your loan, but these cases are not what the request is about.
The problem children are the CMBS loans which are underperforming and which can’t qualify for a new loan. Normally the lender would foreclose and sell the REO. During a credit crunch, the selling lenders finance the sales (they don’t want to, but there’s no alternative). With a CMBS loan, there is no one available to finance the sale – the security holders are not in that business. To move these properties without financing, CMBS servicers will offer huge discounts (remember, it’s not the servicer’s money so they won’t be hesitant to do so).
Why do the owners of performing properties care? Those discounted sales will become the comparables to establish value for performing properties, and the entire market will be devalued. Institutional holders who have to mark their portfolios to market will get clobbered. Further, the buyers of the greatly discounted properties will have a much lower basis and can drop rents and still make a reasonable return, which will also pull down the rest of the market.
What’s the public policy motivation to prevent this from occurring? It’s pretty hard to make a case that a CRE landlord deserves sympathy, but I’ll give it a try. If you rank ordered all the CRE in the country by asset size it would look like a power curve with a very long, fat tail. There are a few very large projects, more large ones, many more medium sized, and a gazillion small ones. Most of the CRE in the country is not held by people like Donald Trump, it’s held by people who have assets but do not live lifestyles of the rich and famous. This is not a bad constituency to help.
If you don’t buy that, there are the financial institutions holding CRE debt. In every recession there are a lot of CRE loans which experience cash flow problems, and when a loan gets into trouble it gets marked down to the value of the collateral. If the only sales are deeply discounted all cash deals, you are going to see some huge writedowns. This will not be helpful. Also, when the buyers of the discounted properties drop rents, more CRE loans will have cash flow problems when they can’t compete with the lower basis properties, resulting in more foreclosures and a really nasty downward spiral. Avoiding this spiral effect should be the main goal of those working to avert a CRE crisis, and making financing available is essential to breaking the cycle.
Finally, we should consider what buying newly originated CRE loans really means. Fannie Mae and Freddie Mac are keeping the multifamily sector afloat, buying conservatively underwritten loans at attractive spreads (currently more than double the margin of single family deals). This could and should be a moneymaker for the Fed.
All things considered, this is a good proposal. Unfortunately, the requestors are not a sympathetic group and the reason for adopting it can’t be summed up in a sound bite, so it will probably not happen.
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