Revival of the fittest

The return of CMBS creates additional liquidity for the European market, but its scope should remain selective.

The recent ramp-up of deal activity in Europe’s commercial mortgage-backed securities market has made 2018 its strongest year since 2015 – and it is only May.

Lenders have already issued four securitisations this year to date, all of them priced tightly, which suggests investors are clamouring for these rare notes, suggestive of a returning market.

The return of CMBS needs to be seen in perspective, though. A few years ago, expectations of a market recovery also ran high, after the issuance of 21 transactions between 2014 and 2015.

Enthusiasm, however, petered out. With cheap central bank financing available and beneficial capital treatment for commercial real estate loans over bonds, CMBS issuance dried up in the two following years to only one or two European transactions per year, according to rating agency DBRS.

Today’s European securitisation market is still a fraction of what it was pre-financial crisis. The issuance of European CMBS deals has totalled €1.71 billion so far this year, far from the €47.3 billion issued in the peak year of 2006, according to research firm Trepp. Compared with the US, running at a pace of about $85 billion for the year, the difference is even more striking.

The European CMBS market has always been smaller than its US counterpart, partly because it is more challenging to write property-backed securitisations in a region with multiple different regulations and lending practices.

But CMBS issuance is now on an upward trend after an 18-month hiatus, with ‘CMBSable’ deals following a similar pattern: underwritings are simpler and more cautious than they were pre-financial crisis; they typically back a limited pool of core-strategy assets, in single jurisdictions and with low leverage in comparison with the previous cycle.

These more straightforward deals are gradually contributing to increased confidence among CMBS investors, as they look for security while seeking relative value against other fixed income assets. On a more negative note, this type of transaction needs specific collateral, limiting the available stock opportunity.

As in other areas of real estate, Blackstone has dominated as a single sponsor in the latest securitisations, which illustrates its ability to continuously buy assets requiring debt to refinance legacy deals taking new leverage. The approach of the US private equity real estate giant towards debt to enhance returns, however, is not as prevalent across its European peers, which could be another factor limiting property-backed securitisations in the region.

Against this backdrop, and keeping in mind that investors’ confidence in the European CMBS market is returning, arrangers might be tempted to push the boundaries to create pools of securities out of more complex loans. In such instances, CMBS investors will have to do their homework to avoid exposure to notes backing commercial property loans that will fail to repay on time once the cycle turns.

It is an interesting time for European CMBS. Strong investor demand across the capital stack suggests there is scope for more property-backed securitisations, offering direct lenders, investors and borrowers an important option for capital and liquidity transfer.

Still, the market should maintain its selective approach to deals, in order to contain risk and avoid a 2008-style market collapse. The gradual growth of Europe’s CMBS will benefit the market – if used for the right deals.

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