The annual June CREFC conference at the Marriott Marquis in New York City was slightly less well attended than Miami (well, no duh!), but low conference attendance and stormy weather didn’t stop over 400 people from attending Dechert’s annual party at the Knickerbocker. The market outlook from the commercial real estate finance crowd this year – perhaps – was remarkably positive given where we are in the cycle. Were we all trying to convince each other, or ourselves? Any unusual anxiety could, of course, be due to the thick fog and heavy rain but the conference itself felt a bit darker than in prior years because there are reasons for anxiety, right? This year, in addition to the tired sports analogies (how many 9th innings can there be?), there were multiple references to driving a car directly into a wall. That’s dark, man.
But fear not if you missed it, as Ted and I will brief you on the main talking points at the conference, the specific issues on which panelists focused and, of course, describe the wild doings of those crazy bankers, lawyers, service providers and miscellaneous hangers on at the damp and misty Knickerbocker rooftop party (spoiler alert – we are, as an industry, largely not good with wild).
Our takeaways from the conference are:
- It’s the unknown unknown that is going to bite us in the rump and since it is by definition unknown, there’s not much use worrying about it.
- Conduit CMBS market share is down. There is lots of speculation why, including the possibility that borrowers still hate CMBS a lot and perhaps have realistic alternatives, particularly in light of the relatively stable floating rate market.
- SASBs are up. There are those investors that really like getting bonds while proceeding through a traditional loan origination process.
- The CRE CLO market continues to grow; it certainly was a bit of a darling of the conference. Really good sponsor-investor alignment plus flexibility to deal with borrower issues really is a winning plan!
- Despite the issues in the corporate leverage debt market and the attendant anxiety, CRE lending competition is hot and borrowers are more in the driver seat today than they have been in quite some time.
And finally – even if the wall is in sight and our foot is on the gas pedal, today’s vehicles are safer and better equipped for a crash than way back in 2008.
Retail, hospitality and the other problem children of the commercial real estate portfolio gave way, or perhaps just made room, for the office sector as potentially the next bump in the road. With the rise of alternative office space, do the corporate tenants lease a similar amount of space during a downturn or will demand flag, dragging down a historically stable asset class? While we’re on office, there was a lot of chat about the gig economy and its potential impact in the office market. Will it shorten tenant leases potentially introducing more volatility into a historically stable asset class? With a business model that has yet to see both sides of a cycle, New York City’s largest office tenant begs the question: Do We Work? Only time will tell.
Much back patting occurred around the continued discipline in CMBS credit standards, unlike the reputed current state of affairs in that dodgy corporate credit world. But what was spoken about with less certainty is the level of contagion that might occur between the corporate credit world and CRE. Would a mash up in the corporate credit world reduce the demand for office space, industrial space and the like?
Returning to the Father of the Feast, Conduit CMBS, there was a lot of grappling with the existential threat facing CMBS through declining volume. Attendees seemed to tacitly acknowledge that the attempt to implement a “borrower friendly experience” in CMBS that has been touted for the past few years has yielded little fruit.
The most common suggestion to fix the problem with CMBS: increase LTVs. Outside of the obvious increase to volume that would result from giving the same borrowers more money, panelists argued that increased LTVs would make CMBS financing competitive with the more risk averse lenders that have been taking market share of late. It is no surprise that few of the attendees championing this cause were the ones who actually purchase the bonds in question.
Beware the doom loop as decreasing CMBS volumes decrease the share of CMBS in most investor target portfolios, thereby reducing the demand for CMBS, thereby reducing the supply of CMBS and around and around we go.
While there was a bit of doom and gloom around, the general consensus remained generally healthy and robust. The rutted trail may darken on the horizon, but for the moment, it’s a super highway and deals are getting done. We have ample sources of capital, delinquency rates are at post-crisis lows and perhaps most importantly, the market participants are taking precautions, buckling up, installing airbags and putting on the high beams. But let us not forget that CMBS, while it remains the Honda CRV of this market, is not the only vehicle in the garage.
Issuers and investors are increasingly turning to the sleek and sophisticated Tesla Model X of the market, the CRE CLO. The June conference attendees were clear that this product no longer harkens to the sparky and explosion-prone CDO of years past. Today’s CRE CLO has become increasingly popular for its match-term investing of non-recourse bridge loans and is picking up the market share that CMBS has lost. The panel discussion at Tuesday’s “Static Electricity” session certainly validated this blog’s prescient embrace of the CLO technology and assured us that despite the complexity of structuring these transactions, investor thirst for short term floating rate paper will continue to increase and issuers will continue to benefit from CRE CLO securitizations.
Tuesday’s Game of Loans session made clear that lenders are racing to meet borrower demands in this overserved market. Those lenders who don’t wish to enter the ultra-competitive track are turning instead to bidding on distressed assets and, like an Uber driver covertly using the Waze app, they are finding new routes and value-add opportunities. While the largest lenders remain conservative when it comes to leverage, they have to give something if they want to get the loans, and that something is covenants. The session ended with some frighteningly frank disclosures on borrower requests that were honored in recent CRE Loans. What was it again that we call those mannequins that test the impact of a crash?
At this point it is almost as if a correction would be welcome, putting everybody back onto familiar ground. What! What are we saying? Apologies. We withdraw the comment.
Oh, and apologies if you read to the end just for the tales of who did what late night at the Knickerbocker, but we’re invoking attorney-client privilege over those events.