Lenders 'securitizing' Southland real estate loans.

Resulting proceeds could fund new construction loans

The "securitization" of Southern California commercial real estate loans has been expanding dramatically since the beginning of 1993, and that trend may eventually free up more capital for local construction loans, industry sources said.

Securitization of commercial mortgages involves underwriting and selling to investors commercial debt securities backed by real estate assets. The vehicles most frequently used to securitize commercial mortgages are real estate mortgage investment conduits (REMICs), collateralized mortgage obligations (CMOs) and rated commercial debt offerings.

According to several sources, the markets for REMICs and CMOs remain fairly quiet, but rated commercial debt offerings are heating up quite substantially.

In fact, virtually everyone in California with commercial real estate debt of more than $100 million is thinking about securitization, said Mitch Rochelle, a partner at the New York City office of Big Six accounting firm Coopers & Lybrand.

"From a debt perspective, finding some kind of debt vehicle is the best way to go so long as there is no lending going on," explained Rochelle. "Notwithstanding the trash talk that California real estate is getting, there is definitely a market for debt securitization."

Basically, rated commercial debt, including securitized commercial mortgages, are routinely sold through public or private offerings. Similar to a bond issue, commercial debt offerings are rated by credit-rating agencies, such as Standard & Poor's Corp., and are traded publicly on stock exchanges or offered to private investors.

The initial beneficiaries of the trend toward securitizing commercial mortgages are the lending institutions. Securitization allows lenders to sell their loans on a secondary market, thereby removing under-performing or non-performing real estate loans from their books.

In the long run, the increasing securitization of commercial real estate loans could benefit the real estate market as a whole. It could be especially helpful to developers in search of financing.

Unlike the residential real estate market, where an active secondary market was established long ago, the commercial real estate market's secondary market is just now beginning to take shape. Industry experts, however, said they see the growing interest in securitized commercial real estate debt as a sign that the development of an established secondary market, similar to the secondary market that exists for residential mortgages, may be under way.

If an active and well-established secondary market for commercial mortgages develops, similar to the one that exists for residential mortgages, new funding may become available for construction loans.

According to tax partner Ed Gonzales with the Los Angeles-based law firm of Skadden, Arps, Slate, Meagher & Flom, the reason for the expansion of the market for securitized commercial mortgages is that investors have grown more comfortable with the concept of securitized debt.

There already exists an established secondary market for residential mortgages and, more recently, secondary markets have been established to securitize and trade other types of debt, such as credit card receivables.

Residential mortgages have been securitized and traded on the New York Stock Exchange since the Federal National Mortgage Association was chartered in 1938. The agency, better known as Fannie Mae, purchases mortgages from lenders, securitizes the loan pools and then sells the securities to investors. Shares of Fannie Mae stock are traded on the New York Stock Exchange.

Establishing an active secondary market for commercial real estate mortgages, similar to the government-created Fannie Mae market for residential mortgages, would increase the availability of capital to buy and sell commercial real estate, sources said, because such a market would enable lenders to refinance their commercial loans more easily.

"One reason that lenders are not making commercial real estate loans is because banks think that there are few options for refinancing the loans," explained Fred Pierce, real estate analyst with the Los Angeles office of Big Six accounting firm Price Waterhouse. If lenders know that they can securitize a loan and get out of the deal, there may be more funding for real estate development in the future, Pierce said.

Historically, securitization of commercial mortgages has been done only infrequently. Nevertheless, owners of underperforming commercial real estate loan portfolios and Wall Street brokers are being increasingly attracted to such securitization because refinancing of commercial real estate loans has remained difficult.

Although deals of this type are few in the Los Angeles area, analysts said they expect to see more Los Angeles commercial real estate securitizations as this trend gains momentum.

The type of property most likely to be a candidate for mortgage securitization is one with a strong, steady cash flow. As Nelson del Rio, managing director of Santa Monica-based investment banking firm Entre Capital stated, the marketability of such securities varies in direct proportion to the strength of the underlying properties' tenants and the length of the leases.

The longer the lease, the better, because that indicates strong cash flow for a longer period of time.