CMBS Securitizing Riskier Deals?

Fitch Ratings warns that hotel/motel loans and interest-only deals were up this year in the Commercial Mortgage-Backed Securities market.

"As issuance volume grows, recent vintages have become more volatile," Fitch Ratings Senior Director Patty Bach said during a conference call with reporters and analysts on Dec. 13. Bach pointed to a surge in hotel lending, which is regarded as riskier than property types that get their cash flow through long-term leases, not overnight visits.

Hotel loans accounted for 16.3% of all commercial mortgage-backed securities issued in 2006, according to Bach, and for the first time surpassed the multi-family assets in CMBS. The share of hotel properties has been on the rise in CMBS since hitting a post 9/11 low of 2.3%.

Interest-only loans are another red flag, because borrowers who use such instruments may be exceedingly vulnerable to economic downturns. Bach says that Fitch has seen the percentage of interest-only loans in multi-borrower deals rise in 2006 and predicts that the number will rise in 2007, too, although the company does not have precise data on the issue.

Hotels and motels are certainly more sensitive to downturns in the national economy, but the impact of interest-only loans seems a little overblown. If we assume an 80% LTV and a 7.5% interest rate, the LTV five years out is only down to 75% if the value remains steady and the amortization is 30 years.

There is some good news in the report:

Fitch reported an upgrade-to-downgrades ratio of 35.5:1 for multi-borrower CMBS deals through the first nine months of 2006, and 29:1 for large-loan, floating-rate transactions.

Which may explain why we're seeing lower spreads on conduit loans.

 
Arizona Top State In Nation for Job Growth

Per Blue Chip Job Growth Update:

Among metropolitan markets with a work force of more than 1 million, the Phoenix area retained the top position in nonagricultural employment for October 2006 over October 2005, with a 5.2 percent gain, representing 94,500 jobs. The New Orleans area bounced back from the post-Katrina doldrums to rank first among metropolitan markets with fewer than 1 million workers, posting a 12.6 percent gain, or 49,700 jobs.

Here's a graphic look at the year over year job growth rate since 2002:

 
Equity Capital Lining Up to Invest in Commercial Real Estate

Interesting article from CoStar on the amount of equity capital pouring into the market:

Hungry for the hefty returns that commercial real estate has consistently returned over the past five years, investors are expected to pour a staggering $55 billion into private equity real estate funds by the end of this year, representing a 48.6% increase over last year's $37 billion, according to Private Equity Real Estate magazine. When you factor in debt financing, those funds have a buying power greater than $160 billion.

Shorenstein started fundraising earlier this year for its eighth -- and by far largest -- investment fund, Shorenstein Realty Investors Eight LP. According to Douglas Shorenstein, chairman and chief executive of the company, the fund was substantially oversubscribed and had to turn away investors before closing out the fund in September, having raised $1.1 billion in equity commitments, including a $100 million investment of Shorenstein's own money.

 
Apartment Condo Conversion Deals Cooling

Here's an article on condo conversion deals that have fallen flat, introducing a new buzzword:

Small said people who don't know the Phoenix market are throwing $4 million to $5 million into conversions while "people here in this market are quietly converting back."

Depending where in the process, developers are "repartmenting," a new national buzz word. If not too many condos have sold in a complex, the developer might offer a condo buyer a swap to another condominium project that has been more successful and then repartment back.

Although here's an oddball claim:

Other developers are being stuck with homeowner association fees for units not sold. For example, if only 20 condos are sold in a 100-unit complex, at $25 per month, that means the developer is paying $2,000 a month in HOA fees for empty condos.

HOA dues of only $25 per month? That seems extraordinarily low.

 
Spec Development On Wane in Albuquerque

As rents have failed to keep pace with construction costs, developers are looking for more preleasing to reduce the risk of developing speculative projects:

In recent years, Angelo Brunacini has been the most ambitious developer of industrial warehouse buildings in the city, building more than 1 million square feet over a decade through his Brunacini Development LLC. He has a prime property at Meridian Parkway, but has not been able to build his 45,000-square-foot building because the numbers don't equate to profitability.

"I've owned the land for 10 years, but if you look at the fundamentals, it doesn't make sense to build without a tenant," Brunacini says. "If I build it, the total project costs me $70 per square foot and I need $7.50 a square foot in rent. Today's rents are in the high $6 range and are moving up fast because of a lack of space. In six months, I may be able to do the project if construction costs hold and rents go up."

 
Job Growth in the Southwest Since 1990

Here's a look at cumulative job growth in selected Southwest US markets since 1990. As you can see, Las Vegas' job growth has been phenomenal in that period, almost twice that of Phoenix, which has substantially outpaced that of the three other markets analyzed here.



Now, it's true that it's easier to rack up eye-popping growth rates when you're a fairly small city, but the fact is that Vegas is rapidly becoming a big town. In 1990, Phoenix had about 7% more jobs than Las Vegas has now. And it's not as if Phoenix has been standing still; in 1990 it had four times the jobs of Tucson; today it's almost five times as many. Of course, all these cities have been doing well compared to most of the cities in the Northeast and Midwest.

 
Yield Maintenance Clause Ruled Illegal?

Here's a press release on a case where the yield maintenance prepayment penalty was ruled illegal:

The Variable Annuity Life Insurance Company (VALIC), a Houston, Tx. based unit of American International Group, Inc. (AIG), has been ordered by a federal court to refund more than $3.7 million to a Chicago real estate development firm for unjust loan prepayment penalty fees it had previously paid, it was announced here today.

Arthur Holtzman, a partner of Pedersen & Houpt, L.L.C. which represented River East Plaza, L.L.C. here, said the real estate development company will receive $3.7 million plus interest as a result of the ruling by Judge John W. Darrah in US District Court, Northern District, Eastern Division. Judge Darrah ruled that River East Plaza should only have to pay 1% on the prepaid balance of $12,301,215 or $123,012.15.

Judge Darrah, following the bench proceedings, said certain prepayment fee provisions in a commercial loan are "unenforceable" penalties.

"Because the yield-maintenance clause of the prepayment provision is an unenforceable penalty, the prepayment provision’s second clause . . . . providing a prepayment charge of 1% of the remaining principal of the loan, determines the prepayment fee. To determine a prepayment fee based on some other basis formula would require the Court to rewrite the contract to impose a prepayment rate not based on an agreement between the parties," wrote Judge Darrah.

VALIC initially demanded the prepayment penalty following the sale of the property at 2700 N. Clybourn here to COSTCO by MCL Clybourn South, L.L.C., the name by which River East Plaza was known at the time of the transaction in 2003. Despite challenges made by River East Plaza, management complied with the prepayment request, paying VALIC a prepayment premium fee of more than $4.7 million.

VALIC, according to Holtzman, had previously refunded more than $825,000 of the $4.7 million prepayment penalty when the borrower recognized that VALIC had miscalculated the amount due, leaving the remaining prepayment penalty at $3,808,505.

"This is a tremendous victory for River East Plaza and for owners of commercial real estate," said Holtzman. "Borrowers should retain the flexibility to buy, sell or refinance properties without fear of onerous prepayment penalties."

It's liable to be a Pyrrhic victory, however, because lenders will either change the clause to require defeasance instead of yield maintenance, or they will be forced to increase their spreads.

 
Industrial Absorption Also Strong

Here's a look at the rolling annual absorption as of the four quarters ending as shown:



As you can see, the absorption is substantially outpacing new deliveries of industrial space:

 
Office Market Absorption Strong

As you can see from this graph:



The square footage shown is a rolling total of the prior four quarters. As you can see, absorption has climbed quite a bit, while new deliveries of office space have slowed:

 
Scottsdale Sales Tax Receipts Show Slowing Construction, Strong Retail Sales

Although Scottsdale's overall sales tax receipts are down by 0.8% over last year, when you look at the breakdown the picture becomes quite positive for real estate investors:

Category fiscal year-to-date changes over prior year: automotive -8.7 percent, construction -21.2 percent, food stores -3.6 percent, hotels and motels +15.5 percent, major department stores +26.2 percent, miscellaneous retail +2.6 percent, rental +7.7 percent, restaurants +7.6 percent, and utilities +0.5 percent.

Declining construction, increasing rentals, increasing tourism and sharply increased department store sales are all good signs for commercial property investors. Food stores down, restaurants up; sounds like more people are eating out.

 
An updated version of Monopoly is coming out which includes Camelback Mountain:

In finishing 11th, Camelback Mountain now sits on the red space occupied by Kentucky Avenue in the original Monopoly board. It will be flanked by Disney World and Waikiki Beach.

 

 

 
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