MARKET INSIGHTS
February 14, 2016

By Andrew Little

Singer Joni Mitchell wrote and recorded “Big Yellow Taxi” in 1970, which became an anti­growth anthem for many environmentalists with its famed line “they paved paradise and put up a parking lot.”

While she most assuredly wasn’t thinking about lenders of commercial mortgage ­backed securities when she wrote the song, those investors should consider the line “don’t it always seem to go that you don’t know what you’ve got ’til it’s gone” as they tighten the screws on conduit lenders.

The first week of February was the annual mortgage bankers’ association convention in Orlando, where about 5,000 industry professionals from all walks of the commercial lending world converged.

The themes were hard to miss: Most conduit lenders made money in the first half of 2015 and then spent the second half trying not to lose it. Insurance companies are looking to put out more money this year and seek to capitalize on the conduits’ misfortune.

Conduit lenders, those that originate and package commercial mortgage­backed securities, are in what only can be described as a death spiral.

Commercial mortgage ­backed securities investors, from the highest rated tranches to the first loss positions, are scrutinizing loan pools so much that it is hard to get any loans closed without an extraordinarily bumpy ride.

At the same time, the bond investors aren’t willing to pay for the top quality loans that they seek.

The combination of difficult loan closings with unattractive pricing has made commercial mortgage ­backed securities groups the lenders of last resort. Thus starts the negative feedback loop. Because conduits are able to attract only the toughest deals, the loans are more highly scrutinized and investors are demanding higher spreads and becoming even more discerning.

But the higher spreads and risk associated with closing a conduit loan are forcing borrowers to reassess their options, which means only tougher deals get closed in commercial mortgage­ backed securities. So while investors of commercial mortgage­ backed securities are working to kill the business they have thrived on for the past 20 years, insurance companies are taking notice.

Insurance companies are at the other end of the spectrum and are excitedly marketing themselves as a stark contrast to volatile conduit lenders.

Many are offering up new programs that are designed to fill in the leverage gap between the standard 65 percent loan­ to ­value ratio offered by many insurance company lenders and the 75 percent max loan­to­ value ratio offered by conduits.

As a result, commercial mortgage rates range widely, according to the John B. Levy & Co. Mortgage Survey.

Top ­quality lower leverage deals are pricing in the 3 to 3.6 percent range for 5­ and 10­year deals, respectively.

Conduit loans are pricing closer to 4.75 to 5.25 percent for 10­ year loans, which leaves a wide gap in between for insurance companies willing to finance 75 percent of a transaction. For those insurance companies, pricing ranges from 4 to 4.5 percent for 5­ and 10­year deals, respectively.

Despite pricing volatility and aggressive underwriting, most lenders are positive on the economy and outlook for commercial real estate.

Many insurance companies are getting pressure from their chief investment officers to increase their loan volumes, and the sector as a whole is expected to increase its origination volume by more than 10 percent in 2016.

Evidence of this bullish commercial real estate sentiment abounds, not only across the country, where sales volume continues to peak, but also locally.

Four major downtown office building have sold since December, with the 24­story Bank of America Center at 1111 E. Main St. selling last week for $42 million. The sale included the office tower, two parking garages and a four­ story office pavilion.

The new owners — a private investment group made up of principals from Washington and New York City — plan to complete a massive face­lift of the Bank of America Center.

The upgrades will enable the building to compete with any property downtown, but at rental prices that are very competitive.