The commercial real estate landscape in the United States is undergoing a significant transformation as more property owners are turning to commercial mortgage-backed security (CMBS) lenders instead of traditional banks. A new report from Moody’s suggests that several factors, including elevated interest rates, property value volatility, and weakened cash flows, have led to tightened lending standards by banks and other CRE lenders through 2023. This has prompted many borrowers, both new and existing, to seek alternative financing solutions such as CMBS loans.
CMBS loans pool individual loans, offering investors the opportunity to focus on the overall credit quality and yields of these securities’ loan pools. As per the Moody’s report published recently, this investment strategy has gained popularity among property owners seeking financing in the current market conditions. Despite an overall decline in multi-loan (conduit) and single-asset, single-borrower (SASB) CMBS loan issuance this year compared to 2022, the second half of the year has witnessed a surge in SASB and CRE collateralized loan obligation (CLO) issuance, according to a report in Reuters.
While approximately 19 percent of the $42.3 billion in performing CMBS conduit loans maturing next year carry a high default risk, investors are drawn to these loans due to the potential for yields of 10 percent or greater. This investor interest is expected to help property owners achieve refinancing, even as lenders have begun to require lower outstanding loan balances as a percentage of property value.
The commercial property market has faced challenges in recent times, with rising coupon rates on mortgages being a significant concern. The average coupon rate has doubled from 3.62 percent in 2020 to 7.21 percent, leaving landlords struggling to keep up with their mortgage payments. Office spaces have been the hardest hit, experiencing rising vacancies as more employees have transitioned to remote work during the COVID-19 pandemic.
Furthermore, approximately $12 billion in CMBS conduit loans that are maturing this year or next have already entered delinquency or special servicing, where third-party assistance is sought to avoid default. While overall CMBS property yields are expected to remain elevated in 2024, about $14.7 billion in SASB CMBS carries yields of less than 8 percent and faces greater challenges in terms of refinancing.
In the event of difficulties in refinancing, these and other CRE loans may find limited interest from buyers. Moody’s anticipates that transaction levels will remain low, similar to 2021 levels, primarily due to wide bid-ask spreads between buyers and sellers, resulting in lower sales prices.
Lastly, borrowers’ debt service coverage ratios have declined closer to one-for-one, prompting an increase in interest-only loans. CMBS and other lenders are continuing to deploy capital in this market environment, adapting to the changing landscape.
