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Jun 23, 2005

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.
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