Commercial Real Estate Debt

Sentiment in the third quarter took a step back, with the Delta variant surge, slower economic growth, supply chain problems, geopolitical concerns, and inflation worries all weighing on markets. The 10-year U.S. Treasury yield dropped by nearly 30 basis points before reversing course and ending the period slightly higher. Regarding inflation, we’d like to reiterate our view that commercial real estate (CRE) can show improved performance in an inflationary environment. The question is whether the increase in CRE cashflows is enough to make real estate ownership attractive in an environment when other assets are also offering higher yields. For CRE debt, higher rates also make a fixed yield less compelling.

The CMBS market did not show much conviction during the third quarter due to both the aforementioned broader macroeconomic concerns as well as normal late summer doldrums. We estimate new issue 10-year fixed-rate AAA spreads were unchanged during the period, with BBBs approximately 25 basis points wider. Secondary markets for these assets showed similar trends. The Single-Asset/Single-Borrower (SA/SB) portion of the market continued to trade with a positive tone, with new deals well received across the capital structure.

SA/SB new issue volume continued to maintain an impressive pace, with $45.4 billion of deals pricing year-to-date—approximately three times the amount sold during the same period in 2020. Conduit issuance of $23.5 billion represents a 17% increase from 2020. Taken together and combined with Agency, Lease, and CLO deals, the volume of CRE debt securitizations is on track to record its highest levels in over a decade. The prior record was reached just before the global financial crisis; however, we are not witnessing anything remotely close to the level of aggressive underwriting from that period.

According to Trepp, the percentage of CMBS loans with a special servicer (a more inclusive measure of distress than a simple delinquency rate) declined for the twelfth consecutive month in September, decreasing to 7.48%. This represents a decline of 224 basis points from the start of the year and a drop of 300 basis points from the prior year peak of 10.48%. Once again, the hardest hit sectors in 2020 led the recovery in the third quarter, with the specially serviced rate in the hotel sector dropping from a peak of 26.04% to 16.84% and retail declining from 18.32% to 13.97%. Office special servicing rates dropped by 33 basis points during the quarter to 2.68%, while the industrial sector continued to shine, ending the quarter at less than 1.00%. Loans secured by multifamily properties also experienced stable specially serviced rates, ending the quarter at 2.53%.

As we move closer to the end of the year, we are expecting increased choppiness.

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While issuance fell slightly during Q3 2021, it remains near the highest levels witnessed over the past seven years.

CMBS new issue spread changes were mixed in the third quarter but remain significantly narrower than several quarters ago.

Delinquency rates continue to decline, led by curing in the hotel and retail sectors.

Interest shortfalls in conduit CMBS are concentrated in the non-rated, first-loss portion of the capital structure.

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AG Capital Markets Perspectives (“CMP”) provides our portfolio managers’ views on the credit, real estate, and private equity markets. To access this quarter’s CMP and past quarterly reports, please complete the form below.

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