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CMBS is Hot

Posted: 3/21/2017
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The recent decline in swap and treasury yields, combined with CMBS spread compression, has created a very attractive situation for borrowers of CMBS product. In fact, pricing on full leverage (75% LTV) loans for bread and butter CMBS product has decreased significantly since the start of the year.

As a reminder, the interest rate a borrower is charged on a CMBS loan is calculated by adding the risk-pricing premium, or “spread”, to a benchmark index, which is typically tied to Treasury bills or swaps. Specifically, the benchmark in CMBS is typically the higher of either the like term Treasury bond or like term swap side offering. These instruments trade daily and can be found very easily on the Internet.

Most CMBS loans offer a 10-year fixed rate and today loans are typically pricing over the 10-year swap. The top graph illustrates how the 10-year swap yield has been pricing over the past 30 days.

The second component of rate, the lender’s spread premium, is a fuzzier concept. Spread generally accounts for perceived risks in the macro markets, as well as micro factors specific to the loan in question. These micro considerations include property type, location and borrower strength as well as economic factors such as underwritten leverage, DSCR and debt yield, amongst others.

With respect to pricing, there exists a strong correlation between how individual loans “price” and the pricing of CMBS bonds in the market. The second graph illustrates spread movement on CMBS bond spreads over the past several years and clearly shows that 2016 was not on overly competitive year for CMBS product.

It is evident from the second graph that spreads on CMBS product have “come in” significantly since their peak around this time last year, just 12 short months ago.

CMBS lenders remain among the most aggressive and ingenious on Wall Street, which affords certain benefits to borrowers that are difficult to duplicate. The following outlines deal points in CMBS that borrowers typically find attractive:

  • CMBS debt is non-recourse, which help keeps the contingent liabilities on your balance sheet in check.
  • CMBS loans offer 10-year fixed rate terms; borrowers who are weary of rising rates can lock in their rate longer than the 5-year terms typical of bank debt.
  • 30-year amortization schedules, often with interest only. This compares favorably to the 20-25 year amortization common in balance sheet deals and can significantly increase the monthly cash flow of the investment.
  • Higher leverage; borrowers can routinely achieve up to 75% leverage (75% LTV).
  • Aggressive cash flow underwriting - Debt Yield minimums of 8.0% and Debt Service Coverage Ratios (DSCR) of 1.25x are common.
  • CMBS lenders will readily allow for “cash out.” This means borrowers with a lot of equity in their deals can access that capital via a refinance on a tax neutral basis and put that capital to work.
  • CMBS lenders are willing to understand “hairy” deals, or those with a “storied” history related to the property, borrower or market. This includes opportunities in secondary and even sometimes tertiary markets.

If you are a self storage investor with a long-term hold strategy, now is the time to act. Interest rates on long-term CMBS debt are historically attractive and lenders are aggressively seeking deals. Compression in CMBS spreads and underlying swaps is favorable for borrowers and lenders are currently offering 10-year fixed rate, non-recourse money in the mid 4% range.

Based on recent comments and actions from the Fed, going forward you can expect volatility and a rise in rates. Current market conditions present an excellent opportunity for investors to take final advantage of the opportunity handed to you by today’s economy. Do not be passive and take unnecessary risk - make the safe bet and enjoy your winning hand for years to come.

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