Conduits ... dealing with them in today’s marketplaceAnthony M. Gramzaconduits, public capital markets, commercial mortgage backed securities, commercial mortgage financing
For those private investors, builders and real estate
entrepreneurs, exposure to the conduit marketplace may be a new
avenue that either you have just experienced, have been looking to
walk down the path, or have just heard a little of a perceived
attractive avenue of commercial mortgage funds.
The legacy of the 1980's real estate debacle and the
consolidation of the financial lenders throughout the country
brought about the world of Wall Street capital markets as major
players in the arena of commercial mortgage financing, and from
that, the world of "commercial mortgage backed securities" (CMBSs).
If you continue to be a player in the real estate marketplace, but
have not yet had any exposure to this means of financing, you
will!
My first real exposure to the conduits took place in early 1994.
Following that presentation, I told all my clients and broker
friends that this would become the true secondary marketplace for
commercial mortgage loans, and it would change the face of
commercial mortgage lending "as we knew it." It certainly has. The
CMBS market provided an estimated $78 billion of financing
capability in 1998, more than three times as much as all the life
insurance companies combined. It is here to stay-so get used to it,
understand its perimeters, and be willing to accept the
underwriting guidelines that are standard with conduit lending and
protection factors for both the lender as well as the
investor/owner. And by the way, this new financing vehicle is not
just the for the "big boys." Several years ago, the minimum loan
was in the one-two million dollar range. Today, we have lenders who
will review and act upon loan requests in the $250,000 range and
up. Therefore, the conduits are open to all segments of the
marketplace.
In August of last year, we experienced a shockwave that made us
all sit up, take notice, and finally understand the "big wave" that
was hitting us. Foreign markets sent out shockwaves when Russia
announced a moratorium on its bond payments. East Asia's severe and
protracted economic downturn didn't help the economists' forecast.
The downturns in the Latin American economy threatened the 20% of
U.S. exports being shipped to that region. Suddenly, many of the
conduits were faced with millions and millions on the table, unable
to sell, because investors were demanding higher yields, which
pushed down the price. The resulting factors were fewer bond sales
and a suffering of heavy losses or lack of warehouse funds by
issuers.
Many conduits pulled out of the business, price constraints were
activated, lines of credit were withdrawn, warehoused inventories
were minimized, and many of the conduits and their lenders had to
re-price their product if they were to have a potential salable
product for the end investor. Underwriting and pricing risk now
became key words in the industry. In order to get a "required
yield," the capital markets must formulate the following:
Starting with a baseline rate for Treasuries, a (credit)
risk-free rate, plus a liquidity premium, plus an information
premium, plus a premium for uncertainty about the timing of
principal repayments, plus whatever other layers of risk investors
attach to a specific asset, will equal final yield.
Believe it or not, most borrowers were okay, since most of the
rates climbed only in the 25-50 basis point margin. Because of the
low-rate scenarios originally quoted in the early part of the year,
most investors were willing to accept the increase and, in many
cases, lenders made accommodations by increases in amortization.
The bottom line was not as hard a landing as originally
anticipated. Several of our investors who were caught in the August
1998 debacle, experienced an increase of 25-35 basis points,
meaning final "fixed" rates in the 7.75%-8.25% range. This is not
bad in a marketplace that just a few years ago experienced a rate
scenario of 9.50%-11.00%.
During the MBA conference in February, it was said that the CMBS
market offers both good and bad news. The good news is that the
public capital markets are a permanent part of the real estate
landscape. The bad news is that the public capital markets are a
permanent part of the real estate landscape. We have to remember
that whatever happens on a domestic level from now on, will have as
much impact as the factors on a global level! However, whichever
way you look at it, the capital markets will provide an
unparalleled access to mortgage capital that will be at competitive
prices, greater flexibility, leverage, and alternative financial
structures.
Good investing.
Anthony M. Gramza, president of AMG Commercial Group, can be
reached at (716) 671-5250 or fax (716) 671-7119.
