The US CMBS market is anticipating the launch of a five-year fixed-rate bond this year, as a vehicle for banks to fund shorter-dated loans to property owners who have seen their borrowing costs double since last year.
Choppy market conditions, falling property values, jitters about a possible recession and uncertainty about office demand have compounded the real estate sector's woes.
These factors caused CMBS issuance to plummet in 2022, in stark contrast to the record-setting year of 2021. Private-label commercial real estate bond supply fell to US$78.5bn last year, down 58% from the US$187.4bn the year before, according to Refinitiv data.
Banks have for many years structured conduit CMBS into mostly 10-year fixed-rate tranches as a long-term funding tool for their commercial real estate loans. For insurers, pension funds and other investors, 10-year conduit CMBS bonds offer long-term, steady income and exposure to a cross-section of property sectors.
But real estate borrowers now have little appetite to be stuck with 10-year mortgages in the event that the current lofty interest rates at 4%–6% fall in a year or two and they are prohibited from prepaying. “Right now, certain borrowers want to avoid locking in 10-year coupons in what they think is an elevated rate environment," said Larry Kravetz, Barclays' head of CMBS finance.
As a result, banks have been exploring the option of bundling short-term property loans and issuing them via CMBS conduit structures, market participants said.
“Borrowers don’t want to borrow for longer duration without any prepay flexibility. They are looking for a short-term product to get through the next couple of years,” said Shaishav Agarwal, Deutsche Bank’s head of capital markets for commercial real estate.
Banks are under particular pressure to respond so clients don't go directly to insurers and private debt funds for financing, market participants said.
There is certainly a pressing need among borrowers for financing in the next 24 months. A little more than half the US$600bn in private-label CMBS loans are scheduled to come due in the next 24 months, according to Yield Book.
High five
There have been several fixed-rate conduit CMBS issues whose entire tenor was less than 10 years, but none have hit the market since the early 2000s. One of the deals that came closest to a five-year profile was a conduit CMBS issued in 2004, GS Mortgage Securities Corporation II, Commercial Mortgage Pass-Through Certificates Series 2004-C1. Its loan pool had a weighted-average life of 6.5 years, according to data from Academy Securities.
Five-year tranches have occasionally been included in conduit deals, but an entire five-year structure will be new.
It is unclear when a five-year conduit deal will make its debut because banks need to amass enough loans to structure a big enough offering to be profitable and to draw investors. Nevertheless, the product is causing a buzz. It was a hot topic at the annual CRE Finance Council conference in Miami held earlier this month.
“We are getting a lot of investor enquiries and interest in the five-year deal, as this is somewhat of a novel structure,” Agarwal said.