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Weaker underwriting standards in U.S. commercial mortgage-backed securities (CMBS) will cause the credit quality of new loans to slip in 2015, though loan quality will remain above its pre-crisis peak, according to Moody’s Investors Service’s “U.S. CMBS: 2015 Outlook–CRE Recovery Takes Root As Loan Quality Continues to Slip.”
“Issuers have loosened underwriting standards as the recovery in the commercial property markets has advanced, increasingly securitizing loan pools of poorer credit quality with higher credit enhancement” says Tad Philipp, director of commercial real estate research at Moody’s.
Loan credit quality at the beginning of 2015 will align with that from the first half of 2006.
“However, there is a danger of credit quality sliding quickly toward the 2007 level,” said Philipp.
“In contrast, outstanding CMBS will continue to perform well in 2015, supported by low capitalization rates that make it easier for these loans to refinance or improve their recovery prospects should they default,” said Keith Banhazl, senior vice president in CMBS surveillance.
CMBS 1.0 loans from the 2006-2007 vintages will find it more difficult to refinance though because they had full proceeds, little amortization, and will mature in 2016-2017 as interest rates rise.
Performance by real estate sector will continue to vary. The supply-demand balance for the multi-family and hotel sectors is currently favorable, but new construction could put this balance at risk and limit further revenue growth.
The recovery in the office and retail sectors, which account for more than half of the collateral backing recent CMBS loans, will advance in 2015. Modest construction rates have allowed these sectors to absorb vacancies, paving the way for rent increases.
Headwinds will challenge both sectors next year though as growth in online shopping pressures the retail sector and a trend toward providing less space per office employee partially offsets the positive effect of employment growth.
Commercial property owners will be able to mitigate some of these challenges by making their buildings more energy-efficient.
“Temperature control and lighting represent two of the largest operating expenses for commercial buildings,” said Philipp. “Sustainable work environments can help attract major tenants and preserve collateral value over the long term.”
Moody’s says that new issuance will grow to $110 billion in 2015, reflecting the strong loan origination pipeline, refinancing of maturing 10-year loans and a healthy property transaction market.