FEATURE: Back in the saddle

With the commercial mortgage-backed securities market showing signs of new life, there could be good news for private equity real estate firms seeking much-needed debt capital. PERE magazine, March 2012 issue

When The Blackstone Group agreed to buy the US mall portfolio of Sydney-based Centro Properties Group last March for $9.4 billion, one might have imagined the deal impossible to finance. However, a significant portion of the investment was funded via the commercial mortgage-backed securities (CMBS) market in a sign that this relatively dormant part of real estate finance was re-awakening. 

Blackstone’s chairman Steve Schwarzman told Bloomberg Television that one of the advantages of a restricted lending market was that his firm could attract financing when others couldn’t, giving it a competitive advantage. Indeed, the transaction between Blackstone and Centro may be a sign that the CMBS market is not only, in the immortal words of Monty Python, ‘not dead yet’, but in fact ‘getting better’. It also is an indication that private equity real estate firms can and should take advantage of this segment of the mortgage market.

A number of industry analysts have noted that securitised loans can be less expensive and more available than conventional senior loans. Furthermore, for some of the larger private equity shops, some loans are so large—like the $1 billion loan underwriting Blackstone’s takeover of Centro’s US portfolio—that they can only be accommodated by a CMBS lender.

Out of the doldrums

With the overall commercial real estate market improving steadily over the past couple of years, lenders gaining more confidence to originate loans secured by high-quality collateral and investors searching for stable yields in an environment with low bond rates and volatile public markets, it is easy to understand why demand for CMBS appears to be returning.

Understandably, few private equity firms are eager to celebrate the prospect of a rebounding securitised market on the record, as CMBS is seen as having played a role in triggering the global financial crisis. However, some sources within private equity shops confirmed with PERE that a revitalised CMBS market could be a positive sign. 

To be fair, the assets being securitised these days aren’t the same as what was being securitised pre-crisis. The elimination of subprime loans, fewer bondholders, the simplification of documents and the arrival of more cautious and studious rating agencies has helped contribute to a potentially healthier and more functional market. 

At its zenith in 2007, CMBS market saw $314.05 billion in issuance globally. In the wake of the credit crunch, however, issuance plummeted to $18.87 billion the following year. The CMBS market reached its nadir in 2009, with just $7.32 billion in global issuance. It seemed as though this sector was, in the words of Dickens, ‘dead as a doornail.’ 

Signs of life seemed to emerge in 2011 as the US economy started to pick up and issuances began to be traded. But with the debt ceiling showdown in the US and Europe facing a sovereign debt crisis, the CMBS market retreated back into its shell for much of the rest of the year. Ultimately, the market capped the year with $36.05 billion in global issuance, nearly half of the $65 billion industry analysts had predicted. 

Resurgence and opportunity

Still, all is far from lost. New research from Deutsche Bank reveals that CMBS was able to hang onto 20 percent of the commercial real estate debt market in 2011. Indeed, many market professionals believe that the increased issuance volume from 2011 offered proof that the resurrection of CMBS is still possible. And ultimately, most industry insiders believe that CMBS will be stronger in 2012, if for no other reason that its numbers have nowhere else to go but up. 

With CMBS issuance potentially rising again in 2012, this should present an easier time for private equity shops to finance their real estate transactions. Indeed, a stronger CMBS market (relatively speaking) will help finance additional and larger acquisitions because the banks are able to sell pieces of the loan onto investors, which in turn helps mitigate their risk. 

“These private equity firms are hoping the CMBS market is available both to finance their acquisitions and refinance maturing loans on properties they already own,” says Ben Thypin, director of market analysis at Real Capital Analytics. “So it’s very much in their best interest to have a robust CMBS market.”

Scott Weinberg, a partner in the real estate and finance practices at the law firm of DLA Piper, also expects to see the private equity real estate sector to be more active in the CMBS market. “If you look at all the commercial banks, a lot are in trouble, particularly in Europe,” he says. With banks potentially less active, this “creates an opportunity for private equity to come in.”

In addition to using CMBS to offload some of the risk associated with large or more opportunistic acquisitions, there are other ways that private equity real estate firms can take advantage of the rebounding space. “The CMBS market can be a place for private equity firms to do some lending,” Weinberg suggests. “Not directly issuing their own bonds, but you may see them doing some originations with the intent to sell those loans to CMBS shops.” 

Bottom line? “CMBS facilitates more acquisitions,” says Thypin. “They offer more debt capital, which is good news for those in need of it.”

Weinberg agrees. “Private equity firms have a lot of money, and it doesn’t do them any good sitting around,” he says. “They’re smart people who are looking for ways to make money, whether that’s through buying properties, originating loans or investing in CMBS lenders.”