After teetering on the brink of extinction only a few years ago following the downturn in 2008, Commercial Mortgage-Backed Security (CMBS) loans are now making a big comeback and all signs indicate that the timing couldn’t be better for would-be borrowers.
Insiders agree that CMBS is one of the biggest stories in hotel funding. “In 2007, CMBS issuance was at $230 billion, then it virtually disappeared,” says Kevin Davis, executive vice president of the hotel investment banking platform at Jones Lang LaSalle (JLL). “It started to make a comeback in 2010 and 2011, and we had $86 billion in CMBS issuance in 2013. This year, some market observers believe it could hit $130 billion.”
The landscape is different than it was. Davis states that there are 37 CMBS lenders now on the scene. “Underwriting is a lot healthier now,” he says. “Prior to 2008, loans were being sized on pro forma value projections. Now LTVs are based on actual values, not pro forma values. Certainly, relative to 2008, lenders are being more conservative in their underwriting. We’re in a 65 to 75 percent LTV environment, but there’s a lot of competition as more and more players are getting into the game, so lenders are becoming increasingly aggressive with LTV rates.”
Banks offer floating rates while CMBS can offer fixed and floating rates, which are now low relative to historical averages. “Both five- and 10-year fixed rate deals can be financed in the mid-4 percent range, and low leverage floating rate deals can be financed at LIBOR plus 200 base points or an all-in floating rate of 2.15 percent,” Davis says. JLL reports that in some cases, floating rate CMBS loans are being originated at leverage levels as high as 80 percent LTV for quality assets, which compares to up to 65 percent leverage for banks. So CMBS is a particularly attractive option. “Currently, floating rate CMBS is cheaper than bank capital,” Davis adds. “CMBS lenders are winning assignments that banks typically received in the past.”
The uptick in CMBS is also significant because it follows several years of improving real estate fundamentals, accommodative federal reserve policy, and the improved health of the banking sector. JLL reports that the cost of floating rate debt generally moves with changes with RevPAR, making it an attractive financing vehicle right now. “From a fundamental perspective, we’re in a good spot. We’re cautiously optimistic that this will be a longer hospitality growth cycle, perhaps nine years, because fundamental economic growth has been slow and steady,” Davis says. “On the asset side, we’re in our fifth consecutive year of RevPAR growth, so it’s possible that this could be a longer recovery with four-plus years of growth remaining in this cycle. Between 2015 and 2017, we’ll start to see maturities peak, so this cycle still has a ways to run its course.”
Both Fitch Ratings as well as Trepp, the information and analytics company which tracks CMBS, report that CMBS delinquencies are at their lowest levels in over four years. Fitch states that CMBS delinquencies should continue to recede and loan resolutions should remain strong due to the fact that share of real estate owned assets (REOs) are at an all time high; on balance, representing 45 percent of total outstanding delinquencies. Trepp reports that it sees continued growth in the CMBS industry in part because there’s lots of capital, and the slow growth since 2007 has created more opportunities to initiate projects, particularly in major markets, since they won’t be held up by supply distortions.
JLL believes that the CMBS market will continue to improve as more players enter the ring and create robust competition. The continued positive growth in RevPAR means that lenders will have increasing confidence toward the hotel sector. This is all good news for borrowers. Davis adds, “It’s an outstanding time to be a borrower and a difficult time to be a lender because the lending landscape has gotten so incredibly competitive.”
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