CREFC held its Annual Conference last week in Washington D.C. Given the current politically charged climate, 2017 felt like a very appropriate time to move the Annual Conference from its traditional home in New York to Washington. Although attendance was down slightly from last year, over 1000 people attended the conference. Dechert hosted a reception on Monday at The Source restaurant for 250 friends and colleagues, where the excellent food and free flowing drinks lasted well beyond the official closing time.
The conference featured a number of new panels this year, including panels on the state of retail and the New York City real estate market. As usual, Dechert was well-represented in the panels and meetings. Dechert's Dave Forti participated in a panel on "The Art of the Deal: Large Loan Challenges in 2017", which discussed the current state of the large loan market and the challenges facing single-asset single-borrower (SASB) securitizations. One highlight of conference was the industry leaders' round-table, which included Dechert's Rick Jones and Laura Swihart, who closed out the roundtable in typical satirical, Washington fashion (Covfefe anyone?)
The mood of the conference was more measured than in January or previous years. The market continues to chug along as it did last year, and few people expect a big jump from the current trend. With interest rates increasing, and both M&A and real estate acquisitions slowing, the drivers that propelled growth over the past several years have begun to stall. Refinancings will continue, particularly for shorter-term floating rate loans, but likely at a slower pace.
Many of the hot topics from prior conferences – such as risk retention, the wall of maturities and the election – were pushed to the side for discussions about real estate fundamentals and the competitiveness of CMBS. In January, many predicted that risk-retention and the wall of maturities would dominate the conversation in 2017, but, in the words of Hillary Clinton, risk-retention and the wall of maturities turned out to be a "giant nothingburger".
Given the current political instability caused by President Trump and Brexit, one would expect to see volatility in the economy and real estate market. In fact, the biggest surprise of the year expressed by many at the conference is the lack of volatility in the markets. The U.S. economy and real estate markets have remained largely stable, with slow but steady growth in both the equity and debt markets. Many expressed concerns that the market may soon be nearing a peak, but the general sentiment was that there will be a few more years of growth before any slowdown.
The biggest surprise of risk retention expressed by many at the conference has been the impact of risk retention on SASB deals, rather than conduit securitizations. Negotiation of third-party purchaser risk retention indemnities has become a gating issue on many SASB securitizations, which has resulted in a decrease in volume. In addition, many large loans which have been securitized as SASB securitizations in past years are now being chopped up and placed into multiple conduit securitizations to create volume. Although the early stages of risk-retention have been difficult for SASB securitizations, CMBS is a natural place for very large loans, and a number of industry veterans expressed the view that SASB would continue to be a significant portion of CMBS market in the future. As soon as we resolve those sticky indemnities...
Although the conduit market has not felt the impact of risk retention as greatly as SASB, it has not gone entirely unscathed. Risk retention has significantly reduced the number of conduit lenders – the top 10 conduit lenders now comprise 90% of the conduit market – but overall volume continues to pace 2016. The cost of risk retention compliance has also largely been borne by the issuers. Borrower pricing has not increased at all in 2017 to compensate for risk retention (in fact, credit spreads have tightened, despite an increase in the 10 year treasury). Although all forms of risk retention have been used in 2017, the market has inevitably begun to migrate towards the horizontal model.
Despite the amount of chatter at past conferences about the wall of maturities, and the resulting refi doom, few people at the conference were surprised that the wall of maturities turned out to be a dud. Many of the better quality properties scheduled to mature in 2017 refinanced several years ago, alleviating pressure on the wall. The market also has plenty of liquidity to absorb the 2017 maturities, and with continuing growth in real estate fundamentals, refinancings have been plentiful.
Of greater concern to many at the conference is the relative competitiveness of CMBS (or lack thereof) to the balance sheet lenders. Commercial real estate lending has continued to grow in 2017, although little of this growth has been seen in the CMBS market, which is largely pacing the output from 2016. Much of the increased volume has shifted to community banks, which are seen by many as the new "lender of last resort". The government-sponsored entities also continue to swallow up a larger share of the market, as multi-family has seen the largest growth of any asset class over the past several years.
In 2016, almost 50% of all CMBS loans were taken out by new CMBS loans. In 2017, only 25% of CMBS loans have been taken out by new CMBS loans, and CMBS accounts for only 15% of the total commercial real estate finance market. Commercial real estate loans have continued to move towards other products and away from CMBS. Will the pendulum swing back towards CMBS? Many questions were raised at the conference about how to make CMBS competitive again, but there were few answers.
What does the future of the real estate market look like? As the economy evolves, the real estate market evolves with it. The big story over the next five to ten years will likely be the impact of technology on the economy and the real estate market. As lenders continue to make long-term loans with five and ten year terms, lenders must anticipate and adapt to the changes ahead.
Retail continues to be the ugly step-child of CMBS – lenders are finding it increasingly difficult to securitize any mall, especially class B and class C malls in secondary and tertiary markets. Although few disputed the fact that retail in America is overbuilt, the retail sector is currently being under financed based upon speculation over the prophesized demise of the industry. Online retail continues to grow at a significant pace, but online retail accounts for only 10% of all shopping. Will we see the complete collapse of brick and mortar retail? It's unlikely, but the market is evolving and it will be up to the real estate industry to catch-up.
As online retail grows, industrial properties have become the new, hot asset type in CMBS. In particular, there is significant competition for "last mile" warehouse facilities which cater to companies such as Amazon. It's likely this trend will continue in the near future.
Technology also continues to impact the office sector. As more companies embrace flex-time and working from home, companies are looking to downsize footprints and provide for more flexible usage of existing space. Unsurprisingly, the hottest growing markets for office space are also in large technology centers, such as Seattle and Austin, Texas.
Construction of multi-family and mixed use properties have continued at a strong pace in 2017, although much of the construction lending has moved away from the banks due to HVCRE rules. Some panelists at the conference expressed concern that there may be overbuilding in certain markets, but at this point in the cycle construction loans continue to perform well. Several panelists noted that construction is not likely to slow significantly over the next 12-18 months. Given the lack of affordability in the multi-family sector, it is unlikely that multi-family construction will slow down anytime soon.
Where does the market go from here? Very few people at the conference expressed the belief that 2018 would be a better year for volume than 2017. In general, most industry insiders predicted that the market would be level for 2017 in relation to 2016, and that CMBS issuance in 2018 would likely fall in the $75 billion to $80 billion range. Although we may be late in the current real estate cycle, growth has remained tempered enough, and borrowers have remained disciplined enough, that we should see another 2-3 years of growth before any real estate downturn.
If we have learned anything over the past year, it is that we should always expect the unexpected. Until President Trump is no longer in office, we believe that remains a good rule to live by. For now, we will keep our heads down and continue to ride the current wave. We'll let you know if it crashes.
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