Real estate CDOs are making a comeback, this time to finance commercial properties shaken by the pandemic

Wall Street’s real estate CDO machine, shunned and largely inactive since the 2008 global financial crisis, has come back with a vengeance.

According to BofA Global, a record of nearly $ 50 billion in “bridge loans” on commercial real estate properties is expected to be turned into bond deals called “CRE CLO”, according to BofA Global, a record that also marks five times the industry. increase from 2020 emission levels.

The new generation of CRE CLO, or secured loan bonds, is mainly anchored this year in commercial real estate loans disrupted by the trend of working from home, which has emptied offices and pushed city dwellers to the suburbs during the pandemic. . These are unlike the CDOs of yesteryear, when Wall Street conditioned billions of increasingly hard-to-sell subprime mortgage bonds and derivatives as “secured debt” or CDOs that became toxic.

The new bonds also give investors a way to bet that U.S. commercial real estate not only survives the COVID crisis, but that with today’s low interest rates, it can land on a more solid footing. over the next five years.

“People thought commercial real estate was the center of the storm,” Tracy Chen, head of global structural credit investment at Brandywine Global Investment Management, said in a telephone interview.

“The doomsday scenario everyone was talking about did not happen.”

Instead, the pandemic has meant a second chance for a corner of Wall Street looking to come out of a bad past.

CRE CLOs are booming

BofA Global, Commercial Mortgage Alert

“Starting with the first post-crisis CRE CLOs, the structures were updated and the optics had to be differentiated from the optics of the pre-crisis CDOs,” said Steven Kolyer, group partner. global finance from the law firm Sidley Austin.

Kolyer was involved when mortgage CDOs first emerged 20 years ago and, over the past decade, has helped incorporate reforms, including requiring CRE CLO sponsors to maintain their agreements by retaining some of the risks.

“These are different from the pre-crisis CDOs which suffered severe credit losses, mainly due to subprime mortgage assets,” he said.

“The current and different credit structure comes at an opportune time as the underlying borrowers with interests in commercial real estate seek ways to shift their properties from past uses to future uses.”

Bridge to the future

Many loans pooled into CRE CLOs this year have been variable rate and used to finance relatively stable multi-family properties, where owners want flexible financing in the COVID era, including to sell if prices continue to rise. .

Others have gone to borrowers in temporary need of funds to reallocate an office building, commercial property or hotel in order to attract new tenants.

Related: Shorter leases? Top real estate executives Durst and Jones talk about the future of the office

“Typically bridging loans were written before COVID, pending disruption in cash flow,” said Greg Handler, head of mortgages and consumer credit at Western Asset Management.

This meant setting aside funds for “a certain period of renovation, relocation or repositioning of properties,” Handler said, which “has helped alleviate the issues we’ve seen with COVID”, including keeping the share of properties low. overdue loans in CRE CLOs.

With the industry booming, Handler has been an investor, but also told MarketWatch that his team explored the possibility of building their own pipeline of transactions. So far, many of the major issuers in the industry have been REITs including Arbor Realty Trust Inc. ABR,
and Bridge Investment Group BRDG,
+ 2.86%,
according to the Finsight transaction tracker.

“Obviously, there’s going to be a need to rethink the future of the office,” Handler said, while also discussing the layout of hotels and other types of properties that are likely to change.

“Homeowners and owners are going to have to rethink and invest more capital,” he said.

Boom like no other

Analysts said the main risks would be sloppier underwriting as lenders compete for business, weakness in the booming multifamily sector or property projects that fail to materialize.

Low interest rate TMUBMUSD10Y,
and muted distress have been credited with helping to raise commercial property prices by 24% on the year, according to the Green Street Commercial Property Price Index, about 15% above pre-COVID levels.

Barclays’ credit research team led by Lea Overby estimated in early December that around 67% of the year’s collateral for CRE CLOs were multi-family loans, with a smaller share coming from the office sector.

But unknowns still darken commercial real estate as the pandemic nears its two-year mark, including around how much office space is needed in major cities, what business travel will look like and others. concerns.

While the anticipated wave of real estate distress did not emerge, Brandywine’s Chen also tied “all risky assets” to central bank support, which until recently meant keeping interest rates low and the accommodative monetary policy.

“The rate is still at a historically low level, and it takes time to bring it to a dangerous level,” she said. “This should benefit the CRE CLOs.

As the Federal Reserve becomes more hawkish, Chen believes real estate “should be a place to hide” if inflation remains high next year, especially for investors exposed to properties financed at ultra-low rates. lows that climb in a rising cycle.

To verify: Will US REITs beat the S&P 500 next year?

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