One unassailable fact is that securitisation has a hugely important role to play when it comes to financing commercial real estate (CRE). Simply put, no other source of CRE finance can provide the high level of openness and transparency that can be afforded by securitisation. Indeed, as demonstrated by the recent financial turbulence, the ability to shine a spotlight on this traditionally opaque market yields dividends when it comes to assessing the true impact and ramifications that the challenging macro-economic outlook is likely to have on the performance of CRE.
At this point in time, it would be fair to say that the capital markets are jittery to say the least, thanks to the severe impact of interest rates rising at a relatively rapid rate and the unprecedented demise of a handful of banks. Although the health of the banking sector has been the primary focus in recent months, market observers have been keen to identify the next domino to fall amidst this turmoil and chief amongst the potential candidates has been CRE. This is a fair conclusion to reach given the tremendous headwinds that CRE is currently experiencing on account of cap rates, interest rates, operating costs (including fuel prices) and financial costs all following an upward trajectory. The corollary of which, is that existing financings are under greater stress and refinancing’s have become more of a challenge with an increasing need for fresh equity injections and/or higher leverage to make such transactions viable. Meanwhile these factors have had a cooling effect on the sales market with it becoming harder to price CRE.
This brief epilogue of the perils that CRE is currently facing is sobering and provides clear justification why many believe that CRE is in the firing line. However, those looking to draw parallels with the global financial crisis (GFC) will be sorely disappointed as the debt secured by CRE is a very different beast to what we saw being originated in the noughties. Generally speaking, loan structures are a lot cleaner and easier to enforce. Leverage levels are more conservative compared to the crazy levels reached prior to the GFC and sponsors have a lot more skin in the game and therefore less inclined to unceremoniously hand over the keys at times of distress. Despite the challenging headwinds, the CRE market should be confident with its ability to weather the current macro-economic storm given the more conservative underwriting and improved loan structures.
The crux of the issue is the inability to confidently determine the current state of the CRE market and, more importantly, whether it is managing to weather the macro-economic storm. This is an issue of profound frustration and denotes a major flaw in the European CRE lending market. In an ideal world this information should be readily available for all to digest and be used to form educated views on whether CRE is indeed the next domino to fall or otherwise. This lack of transparency is not only hugely unhelpful but allows market harbingers to provide negative speculation, which for an industry both buoyed and sunk by sentiment, is truly toxic. This unjustifiable opaqueness is not only a flaw in the lending market but is also a major advertisement on the huge merit that securitisation can play as a tool for financing CRE.
Regardless of whether a public securitisation takes the form of CMBS or CRE CLO, the bottom line is that transparency and openness are in bountiful supply. After all, ahead of any note issuance, a prospectus is issued that provides comprehensive information about not only the loans but also the CRE that secures such loans. Following note issuance, ongoing reporting, in the form of quarterly reports, allows the market to regularly track performance. In addition there is a real time ongoing obligation on the securitisation issuer to make disclosures about any material events that are likely to have an impact on a loan and the underlying CRE.
When it comes to the tracking of performance of loans and the CRE that they finance, securitisation can act as a beacon of best practice and be an educator in its own right. After all, securitisation through the public transmission of real time information has a role to play in educating the wider market on not only the performance of loans but also what actions are being taken to resolve and address issues when securitised loans become stressed. Indeed, in today’s market, had securitisation been more widely adopted, we would be in a far stronger position to make a reasoned assessment on the state of CRE.
I would argue that now is the moment to embrace securitisation at scale for a number of reasons, chief amongst which is that these structures create the much need openness and transparency currently severely lacking in the European CRE market. Indeed, if we were fortunate enough to have a significant amount of European CRE financed by securitisation, then a lot of the negative concerns and jitters currently embattling CRE would simply vaporise and in its stead be replaced with hard solid facts for the greater good of all.
As focus turns to the annual IMN Global ABS conference in Barcelona next month, there will be a real opportunity for the market to meet and consider how we can do better to embrace securitisation technology. Personally, I am very much looking forward to speaking on the panel about CRE CLO’s, which I believe will not only have an integral role for financing European CRE but this product has a massive role to play in shining a spotlight on CRE and, by doing so, alleviate many of the issues and concerns that the market is currently confronted with.