Residential mortgage problems started the current financial market meltdown. Many experts are now worried that the commercial real estate market may collapse and extend the current crisis.
What is the commercial real estate loan market?
It’s the market for debt used to finance hotels, offices, and shopping malls. Most of these loans are issued to institutions and private companies.
What’s a proxy for the CMBS market? Size of market?
A widely followed index that started in 2004 and tracks a basket of commercial real estate-backed securities is the Markit CMBX.
As of 2007, the commercial real estate market was $3.1 trillion, with 25% of this market being in CMBS. (Source). Thus, the commercial real estate marked as a whole is much smaller than the $12 trillion residential market in 2007.
Visit this article (link) for a more detailed description on CMBS.
Indicator of future collapse?
As this Reuters article shows, Goldman Sachs has retreated itself from the CMBS market. It’s doing the same thing it did in late 2006 when it reduced its exposure to residential mortgage-backed securities and managed to escape a lot of the sub-prime collapse. Here is an excerpt:
Goldman recently reported owning $6.4 billion in commercial mortgage loans. It also is holding some $1.6 billion in commercial mortgage-backed securities, or CMBS. That’s a big retreat from where it was just two years ago.
And in a sure sign that Goldman expects a good number of commercial real estate borrowers to default, the firm says it marked down the overall value of its commercial mortgages portfolio by nearly 50 percent.
Goldman used to have a rather large footprint in the commercial real estate market, with some $16.27 billion in loans and $2.75 billion in CMBS on its books in late 2007. That year, Goldman ranked seventh in bundling commercial mortgages into securities, churning out $15.1 billion in so-called CMBS, according to Thomson Reuters.
If the best performing ex-investment bank is taking 50% write-downs and selling, there is a high probability that something bad is likely to happen. Goldman also stated (but did not disclose) that it had hedges on its CMBS market exposure.
Another indicator that the market may be deteriorating is how the CMBX index has been trading. As of now, the main Markit indexes for tracking the performance of the highest-rated CMBS are off 10 to 13 points from their respective par values. However, the Markit index tranches for tracking the performance of subprime-backed debt has dropped by more than 80 points at it’s low.
What would lead to a collapse?
The commercial real estate market involves the sectors in the economy being hit the hardest: malls, and hotels (tourism, vacations, etc), and other types of discretionary spending. The recipe for disaster would be a higher savings in the U.S. and even greater declines in mall, hotel, and resort traffic.
Research company Trepp LLC states that default rates in the CMBS market could double in 2009 and reach 6-7%. They also state that CMBS delinquencies have historically lagged the economy by 12-18 months, which means that there could be more to come in 2010. [Source: Seeking Alpha]
What has been done or can be done to avoid a collapse?
One of the programs from the Federal Reserve’s [alphabet soup] programs is TALF (Term Asset Loan Facility) and it covers commercial-backed securities.
TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and business ABS [asset backed securities] at more normal interest rate spreads.
Source: New York Federal Reserve
The size of the TALF program is $1 trillion; however, the money is for all asset-backed security markets (i.e. car loans, credit cards, etc). Given the size of the CMBS market, it may only be able to make a dent.
Is TALF working and/or is the market improving?
The program has just started to get into full gear. It will probably take some 6 months or so to see any solid results.
As of now, things seem to be progressing on the positive side as a $500-600 million bond sale is planned to happen through the program in the fall of 2009. [Souce: Wall Street Journal]
In general, the CMBS market is a big and essential part of the U.S. economy. It’s collapse would likely create more chaos and disrupt our economic recovery (which markets are indicating is around the corner).
{ 2 comments… read them below or add one }
Our research and re-underwriting indicates that there will in fact be many CMBS going into delinquency and default and we will not be at all surprised that the number reaches 10% by the beginning of 2011. Our investment strategy calls for identifying and buying the “good” CMBS issues by re-underwriting all of the CMBS to screen out the ones headed for trouble. Sadly, we have found only nine (9) CMBS issues that we believe will NOT see capital losses in the AAA AJ’s. This means that we believe that it is highly probable the remainder will not only see the “B pieces wiped out, but the A ‘s , AA’s and some or all of the AJ’s as well. Interestingly, we identified CMBS issues in the ones approved by Treasury for TALF-PPIP that we are sure will see losses in the AAA tranches.
Charles,
Thanks for sharing! I thought it was bad, but not that bad!
I wonder what the impact will be when that happens.