In commercial real estate (“CRE”), the 2016 and 2017 “wall of maturities” for commercial mortgage-backed securities (“CMBS”) has been a discussion topic for years (Figure 1). The loans in this wall of maturities were underwritten during the pre-crisis lending boom. And while many have refinanced or are expected to refinance with long-term debt, a significant portion of borrowers face a much different lending landscape today. The CMBS market, a historically large source of CRE lending capital, is significantly smaller because of increased regulations and tightening lending standards. Against this backdrop, numerous borrowers are exploring the bridge loan market to meet their refinancing needs.
Bridge loans are fixed or floating rate, shorter-duration first mortgage loans used to "bridge" the borrower to a sale of the property or permanent financing. These loans also receive efficient capital treatment for insurance company lenders with average ratings of CM2 typically migrating higher to CM1 during the term. Bridge loans can be an effective source of refinancing for CRE borrowers who do not have access to traditional, long-term fixed rate loans due to lower current in-place cash flow or an expected transitioning of the underlying property. Additionally, many of these properties are located in secondary or tertiary markets where CMBS historically dominated as the source of CRE debt. During the pre-crisis lending boom, many borrowers owning assets with these characteristics had access to long-term capital through the CMBS market, but that market has changed.
Traditional bank lenders, including most CMBS participants, face new constraints from regulations enacted by Dodd-Frank and Basel III. As recently as early 2015, CMBS still remained the largest source of CRE lending (Figure 2). However, market uncertainty related to the impact of Dodd-Frank risk retention rules caused a significant reduction in debt capital from CMBS borrowers in 2016, and some expectations for 2017 are lower still. Another outcome of risk retention, which effectively requires either the securitizing bank or first-loss investor to hold a 5% piece of the entire CMBS transaction for a minimum of five years, is the resulting increase in credit quality. CMBS lenders have focused on higher quality loans to attract holders of the risk retention piece and help offset the illiquidity. Both regulation and the resulting tighter lending standards have forced borrowers of transitional or stabilizing properties to pursue other higher cost CRE capital in order to meet their refinancing demands.
We believe the current dynamic in the CRE market is creating a compelling opportunity for investors in bridge loans. In simple terms, it’s a story of supply and demand. The declining supply of CMBS capital is being met by high demand for CRE loans as borrowers face significant near-term loan maturities. For lenders providing bridge debt on transitional properties, this imbalance creates pricing power. In fact, spreads for bridge loans tend to be in the LIBOR+400-500+ basis point range. At these levels Voya believes bridge loans offer compelling absolute, risk-adjusted and capital-adjusted yields relative to not only other CRE loans but other asset classes as well.
Source: Mortgage Banker’s Association, as of December 31, 2016. Represents total maturities by investor type.
Source: Real Capital Analytics, as of December 31, 2016. Represents share of CRE lending based on independent reports of properties and portfolios $2.5 million and greater.
Past performance does not guarantee future results.
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