The commercial mortgage-backed securities taken out 2006 and 2007 that are coming due are not causing much stress for lenders or borrowers, according to industry players.
However, several factors threaten to increase the cost of CMBS refinancing. The Dodd-Frank Wall Street Reform and Consumer Protection Act’s risk retention rules deadline, for one, is just around the corner. By Dec. 24, CMBS sponsors must comply with this new “skin in the game” regulation, which requires sponsors of asset-backed securities to retain at least 5 percent of the credit risk of the assets underlying the securities and does not permit sponsors to transfer or hedge that credit risk during a specified period.
But so far, capital is still readily available and refinance terms are attractive.
Elliot Eichner, co-founder and principal of real estate investment banking firm Sonnenblick-Eichner, said that as recently as early September, quotes for CMBS refinancing don’t appear to be reflecting any premium to account for required retention of credit risk, but it is expected that the cost will be passed on to borrowers.
In fact, Eichner said it remains a borrower’s market—so much so that the firm’s CMBS refinance clients are opting to pay defeasance fees, also known as prepayment penalties.
“The expectation earlier this year was that, as we sit here in September, that the interest rates were going to be higher,” he said. “Nobody knew that back in January. … The markets are good now, rates are good, cash flows are there. So our clients are saying, ‘I’m going to pay the defeasance.’”
The defeasance payoff is a bet against future interest rate hikes and premiums paid on CMBS that includes the Dodd-Frank risk retention rules, according to Eichner.
“At the beginning of 2016, we expected credit spreads would increase by 20 to 50 basis points to offset [the risk retention], now it looks like it could be only 20 to 30 basis points,” he said. “We have not seen it as of yesterday when we were getting quotes. We thought that we would, because anything that is financed now is probably not going to get securitized until after Dec. 24.”
There was even an expectation that summer refinance deals would see this premium, but that did not happen, Eichner said.
The CMBS maturity wall will create more volume, said Steve Kirby, principal of hotel broker Mumford Company.
“It’s going to be heavy and there is going to be a lot of demand for credit, but at the same time, there’s a lot of debt capital available right now out there,” he said. “Lenders are going to be able to be more selective in terms of assets they want to underwrite, so that’s the downside to borrowers—there will be more competition to borrow than there will be to lend so less attractive borrowers will pay more.”
Steven Fischler, president of Hospitality Funding, a financial advisory firm, said this is happening now.
“If you’ve got a good property, a qualified sponsor and you have the ability to write an equity check, you can refinance at much cheaper rates than the loans you took 10 years ago,” he said.
Market data also indicates that hotel CMBS maturities are under control. According to Morningstar’s most recent CMBS maturities report, of the four major property types, hotels had the highest payoff rate at 86.2 percent. Hotels accounted for 10.6 percent of July’s maturing balance. Typically, hotels account for no more than 15 percent of any CMBS loan stack.
Suzanne Mellen, senior managing director-practice leader at HVS, said it appears that the market can handle the needs. “Some new players have stepped up in the absence of the CMBS market,” she said.
Mellen noted that we are at the tail end of very long economic run.
“It raises some concern for the hotel market,” she said. “The market has come back a bit—activity is going on, but it’s reduced. The pools of loans that are going out are reduced in size; they are in the $700-million to $800-million range where before were above $1 billion. And hospitality is still 15 percent or less of the pool.”
Within capital markets, hotels are viewed at the high end of the risk spectrum, so if there are any shocks or risk to the performance of hotels, borrowers may have a challenge refinancing, Mellen added.
Brand (Still) Matters
Franchise flag makes a huge difference in refinancing, Fischler said.
“The world views certain brands differently,” he said. “Historically, if you look back at rating agencies’ support and why they take that position, you definitely see from CMBS difference in aggressiveness, leverage point, rates, as you move between the different brand types.”
Kirby said it could be 100 basis points higher to borrow “as you go down the food chain for age or brand.”
Capital expenditures, often related to brand requirements, also are a factor for borrowers.
“Values and cash flows are well above what they were 10 years ago, but in some secondary markets the values are still below what they were in ’06 or ’07 so they will have to come up with some equity to refinance,” Mellen said. “That’s a market-by-market issue. They could be up for a [property improvement plan] or brand re-up, and then they might not have $4 million to spend on the PIP. They have to come up with equity or come up with a capital solution.”