The Wall Street Journal, in “Fitch Sees Rising Shakiness In Commercial Mortgage Arena,” tells us that the rating agency issued a warning Wednesday on frothy lending in the commercial real estate arena.
The problem with this story is that the WSJ makes it sound as if that’s news. It isn’t. The Financial Times reported on this in early April, citing an earlier Fitch report. There also has been coverage on Seeking Alpha of the same topic.
I don’t see why the public at large is worried about the prospect of a Murdoch takeover of the Journal. They’ll be losing less than they imagine.
From the Wall Street Journal:
Defaults on loans backing commercial mortgage-backed securities could soon begin to rise, as some owners of buildings purchased for high prices find they were too optimistic about future market conditions, a credit-rating company warned.
In a report yesterday, Fitch Ratings said the fervid lending conditions from 2005 until early this year allowed landlords and real-estate developers to load up on interest-only loans and loans with high loan-to-value ratios that were underwritten with expectations for rent increases that appear “unrealistic.” While commercial rents are rising at the fastest levels in many years — especially in some of the strongest commercial markets, including New York and Washington — Fitch said owners have “overly optimistic expectations of future rental rates, sales growth and market growth.”
The warning comes as investors have become more cautious about financing these deals. In the last three months, lenders have pulled back somewhat, tightened covenants and required borrowers to put up more cash. Meanwhile, interest rates have risen, making it harder to use borrowed money to amplify returns. “It’s clearly had an effect on the number of people chasing deals,” said Colin Dyer, chief executive of Jones Lang LaSalle Inc., a Chicago commercial real-estate services company. “It’s taking deals longer to get completed, and it’s stopped price growth for now.”
As investing in commercial real estate has surged this decade and sales prices have skyrocketed, lenders competed aggressively to win market share. Some loans used so-called negative leverage — when a buyer’s debt payment is more than the income the property produces. In the past, banks underwrote loans based on current cash flow — typically the rents landlords receive from tenants. As the market heated up and banks competed against each other to produce loans, some began underwriting loans based on expected future income levels.
Even though lenders have turned skittish in recent months and have started to require more equity in transactions, the higher risk loans that were written previously are now working their way into pools of loans packaged into commercial mortgage-back securities — thus, raising the likelihood of higher defaults for the rest of 2007, said Fitch.
Some of these riskier loans, especially in the white-hot Manhattan office market had been based on the current pace of rent increases-about 25% in the past 12 months in Manhattan — continuing for 10 years or more. “It was not just one bank doing this,” Britt Johnson, a senior director at the ratings agency and a co-author of the report. “It was a common practice across originators.”
That kind of aggressiveness, combined with the fact that CMBS default rates are at historic lows, led Fitch to predict the default rate will rise this year for the first time since 2003. The current default rate is 7.88% for CMBS issued in the last 10 years.
“If you look at historic levels of delinquency compared to today — they’re so low by any measure that it’s only natural to conclude that there’s likely to be an increase,” said Tom MacManus, who heads the debt and equity group for Cushman & Wakefield Inc., a New York commercial real-estate services company.
