Bubble fears increase in the commercial mortgage backed security market
Voya Financial's Christine Hurtsellers said she's staying away from new issues of commercial mortgage-backed securities, echoing concerns from Federal Reserve officials and bond graders about loosening underwriting standards in the market.
"We don't forecast a bubble per se, but definitely it's starting to get frothy," Hurtsellers, chief investment officer of fixed income at Voya Investment Management, said at an event in New York, discussing the group's outlook on markets. "It's something we're keeping an eye on. And therefore, we are not buying any, really, of the new issue deals but focusing more on older kind of seasoned deals that are available."
Soaring commercial real estate valuations have returned in some markets to levels not seen since before the 2008 financial crisis, according to a Moody's property price index. Banks reported stronger demand in October for various types of commercial mortgage debt, including construction, commercial and multifamily housing loans, according to the Fed's most recent senior loan officer opinion survey.
Competition among lenders and finance firms is driving worries that underwriting standards have relaxed too far, Wells Fargo & Co. economists Anika Khan and Michael Brown said in a report. The Office of the Comptroller of the Currency reported in its 2014 survey that underwriting standards on multiple types of real estate debt eased for a third consecutive year.
"Within CMBS, we're starting to see behaviour where loans are being underwritten based on pro-forma, optimistic rent growth as opposed to, sort of, in-force rent growth," Hurtsellers said. "So whereas in the housing market for example, we're nowhere close to the sort of behaviour that we saw pre-crisis. In commercial real estate, we're starting to see those same types of things."
New issuance volume for the most popular kind of CMBS in 2016 is expected to be tempered by competition from other financing alternatives, keeping projections between $70bn and $80bn, Barclays analysts Jasraj Vaidya, Aaron Haan and Mengbai Wang wrote in a report this week. Some analysts argue that recent pricing weakness is a buying opportunity for investors able to weather volatility in current yield premiums.
Certain parts of new CMBS deals "remain one of the cheapest fixed-rate AAA assets available and a haven for those looking to reduce risk exposure within CMBS," the Barclays analysts said.
The uneven recovery in national real estate can be seen in coastal markets such as New York and San Francisco. Those markets may be on course for a slowdown, Hurtsellers said, citing concerns about overexposure to startups and technology companies.
"If we start to have challenges with some of these IPOs not getting done, and maybe the techn sector slowing, that would make me much more concerned about commercial real estate," Hurtsellers said. (Bloomberg)