An esoteric, and somewhat tarnished, corner of the mortgage bond market has moved firmly into mainstream.
Commercial real estate collateralized loan obligations, also known as CRE-CLOs, appeal to investors now because the securities that they issue pay floating rates of interest and are relatively short-term. These securities typically have initial terms of two or three years and can be extended several times for a total term of four or five years. By comparison, more typical commercial mortgage bonds pay fixed rates of interest and have terms of seven to 10 years.
Several nonbanks looking to expand in multifamily lending have seized on the product as a new source of funding. Several of these lenders, including Greystone and Hunt Mortgage Group, originate large volumes of multifamily loans for the Federal Housing Administration, Freddie Mac and Fannie Mae. They also specialize in what is known as “transitional” lending, or short-term, floating-rate loans on commercial property buildings that are being repurposed or fixed up in order to eventually qualify for cheaper, longer-term financing.
These transitional loans — also known as bridge loans — have traditionally been kept on balance sheet. But with interest rates headed higher and the multifamily market still going strong, it has become attractive to securitize the loans. The funding is longer-term and less expensive than other sources of capital, such as bank lines of credit, putting nonbanks in a stronger competitive position.
“To some extent, this demand [for bridge financing] is increasing as commercial banks continue to reduce their lending,” said Jeffrey Baevsky, a senior managing director in charge of structured finance at Greystone, which issued its first CRE-CLO, and the first such deal of the year, in March. “We’re taking business away.”
The CRE-CLO market is pretty small. In 2015, 13 deals produced $5.5 billion of issuance, and last year there were just nine deals worth $2.7 billion, according to the credit rating agency DBRS. But in 2017, things picked up, in part due to new entrants such as Greystone that are focused on the multifamily market. And the sector got a significant boost in December when the Blackstone Group issued the largest CRE-CLO since the financial crisis. The $1 billion transaction was backed by some very high quality properties, and it included some unusual features. The sponsor has the ability to meaningfully modify up to 10 loans in its portfolio, even if they are performing, for example.
J.P. Morgan expects 2017 issuance to settle at around $6 billion, and it’s calling for a similar level in 2018.
While the multifamily market has soft spots, demand for rental housing is still strong, particularly for affordable rental housing.
And there is some thought that heavy construction of high-end apartments is putting pressure on landlords to spiff up older properties, according to Erin Stafford, a managing director at DBRS.
Stafford said that CRE-CLOs finance reinvestment in properties to ensure they remain competitive and continue to get market, or closer to market, rents — and potentially qualify for government-sponsored-enterprise financing. “There’s a lot of new product coming online that is Class A, whereas CRE-CLO transitions typically finance more workforce housing, Class C and B,” she said.