While questions about the rights of CMBS investors in bankruptcy cases and other risks persist, there are offsetting trends that continue to drive the securitized commercial mortgage market toward a comeback, according to Mark Edelstein, chairman of Morrison & Foerster's real estate finance group.
Edelstein — who said his firm has represented various parties in high-profile bankruptcy cases such as General Growth Properties — cautioned CMBS investors to keep in mind that a judge "might not respect the structure and/or some of the protective features that you thought you were buying into." Edelstein, whose CMBS litigation experience also has included work with Extended Stay Hotels, said there arose in that case and others "fundamental questions never answered" by the courts or addressed in deal structures regarding whether going forward courts will "recognize CMBS structures at all."
In contrast to other bond or a syndicated loan deals where legally investors hold notes that give them the right to a piece of the borrower¹s debt, in securitizations mortgages are sold into trusts that are in turn selling to investors pieces of those trusts rather than giving them direct rights to the collateral that those trusts hold, he said.
This has raised questions about whether "certificate holders have the right or standing to show up in court and protect their interests," he said. "The answer under the CMBS documents is no, but whether the courts actually bear that out we'll only know through other cases."
Among examples of where this could occur would be the Stuyvesant Town case, where there are intercreditor agreements with mezzanine lenders and questions about whether those will hold up as expected and /or intended.
"There could be a chipping away of CMBS protections in the deals and it could take a couple of years to see how these hold up in the courts," Edelstein said.
Part of what it driving demand for deals despite the risks is the fact that there is more capital available to make loans and buy property than there is the ability to deploy it.
"There's a great desire to put out money," Edelstein said.
In addition, while real estate fundamentals may not be better than six months ago, CMBS relative returns are attractive in comparison to those of other investment options today.
Also, CMBS loan underwriting is currently at conservative levels that market participants have commonly been describing as similar to those seen in the early 2000s. "When you put the two together, maybe it¹s not a bad time to invest in CMBS," Edelstein said.
Then again, there is the aforementioned litigation risk, and other concerns as well. These include uncertainty related to the ability to replace maturing debt, and extension risk that has been "manifesting itself in different ways," he said.
Recent history with defaulted CMBS loans has resulted in changes that address some risks by giving 'AAA' investors the ability to put greater pressure on special servicers in workouts. But those investors could end up with less control over their destiny in the future if the market opens up again and their buying power diminishes, said Edelstein.
"The pendulum could start swinging back," he warned.
Other developments investors might want to keep an eye on could be the question of whether New York's commercial real estate market is in a "mini-bubble" as a result of there being "so much capital out there looking to buy deals" and the New York market being "better than in many parts of the country."
His firm and others have been surprised at how high sale prices of commercial assets have come in. Competition between investors looking for assets in a market with a limited number of commercial real estate deals in New York could be responsible for this, he said.