Better CMBS bond yields, risks stall new originations.

Commerical real estate investors find commercial mortgage-backed securities bonds more valuable in yield and risk than actual properties securing them.

The Inland Real Estate Group of Companies Inc., Oak Brook, Illinois, started purchasing commercial real estate underlying CMBS bonds rather than direct property because it recognized commercial real estate underlying CMBS bonds held double-digit yields at lower risk, said Dan Fasulo, managing director at Real Capital Analytics, New York.

"There are sharp investors out there who realized the old [bonds] have value," Fasulo said. "They wouldn't even look at a new issue."

Inland told MBA NewsLink that any CMBS purchases were done through its non-traded real estate investment trust, Inland American.

In a Feb. 27 letter to its shareholders, after five property acquisitions this year, the REIT said, "Our objectives are to invest in real estate assets that produce attractive current yield and long-term risk-adjusted returns to our stockholders. We believe that the optimum use of capital at this time is to acquire higher-yielding real estate assets that we are seeing as a result of the dislocation in the financial and real estate markets."

Industry analysts said life companies started making indirect investments into commercial real estate through CMBS rather than direct lending, and they forecast more of the same.

"The argument, of course, goes, 'Why would I lend at 6.5 percent or 7 percent, albeit to my best clients, when I can go in and buy [commercial] mortgage-backed securities at 1,100 basis points over 10-year swaps?' You're looking at an 11 percent to 12 percent return," said Ross Moore, executive vice president and director of market and economic research at Colliers International, Boston. "Do I go into that market and get a 12 percent return--AAA--or do I stick with my base model and lend to decline?"

Fasulo said investors continue to hold CMBS bonds because of lower market value in the current economic environment and because the loans still perform.

The PricewaterhouseCoopers Korpacz Real Estate Investor Survey for the first quarter said real estate investors do not expect a rebound in any of the commercial real estate sectors "until well into 2010."

The report said national regional malls are at a "standstill," power centers are struggling and "office markets crumbling."

"Demand has weakened for office space, and many traditionally strong markets are seeing vacancy increase," the report said. "As supply outpaces demand, the average initial-year market rent change rate remains on a downward trend in the office sector, dropping roughly 260 basis points over the past year in the surveyed office markets. Furthermore, property values are expected to drop as much as 30 percent nationally over the next year in the central business district and suburban office markets."

More than one-third of investors said local banks are their primary source of debt and nearly 20 percent said they are turning to private equity, according to the United States Select Service Hotel Investor Survey from Jones Lang LaSalle Hotels (JLL Hotels), Chicago.

"Many such smaller banks were able to sidestep the sub-prime mortgage meltdown and were not involved in CMBS debt syndication," said Al Calhoun, managing director of the select service division at JLL Hotels.

With delinquencies and foreclosures rising, lenders are also extending loans, if possible, including a "standstill arrangement" until March 24 on $84 million of debt for a large United Kingdom sporting goods retailer, JJB, as it finalizes "disposal" of its fitness clubs.

Investors acquiring properties can still find alternative financing sources but at lower amounts.

Calhoun said hotel investors are not only looking at local banks, but also government-sponsored Small Business Administration- and Department of Agriculture-guaranteed loans.

"Full-service hotel transaction volume has slowed substantially, but there still remains steady investor interest and trading activity in the select service market as pockets of financing are available for hotels trading for $15 million and below," Calhoun said.

Loan assumptions or seller financing could help acquisitions close, but they do not add new originations.

Prior to the Feb. 27 letter, Inland American acquired five commercial real estate properties this year, but only one deal included a new commercial mortgage origination.

Inland assumed loans for The Pavilion at LaQuinta and Dothan Pavilion, which closed on Feb. 18, and Sanofi-Aventis, which closed on Jan. 28. It received seller financing on the other transaction.

The Pavilion at LaQuinta closed at London interbank offered rate (LIBOR) over 1.85 percent and increased to LIBOR over 2,5 percent on April 28, while Dothan Pavilion, assumed at LIBOR over 1.7 percent, will increase to LIBOR over 2.5 percent on Dec. 18. Sanofi-Aventis, closed on Jan. 28 and assumed at S190 million, carries a 5.7465 percent rate that matures in December 2015.

Inland American received new financing for Brazos Ranch, closed on Jan. 21 for nearly 515.5 million at 5.67 percent. The loan is scheduled to mature in February 2014.

Michael Murray is editorial manager of MBA Commercial/Multifamily NewsLink. To subscribe, please visit www.mortgagebankers.org/getnewslink.