CMBS in 2018: The Rating Agencies’ Predictions

Erin Stafford,  Head of North American CMBS at DBRS

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We are expecting volume to be flat compared to 2017. The lion’s share of the increase in U.S. CMBS volume in 2017 came from increased issuance in the single-asset, single-borrower (SASB) market, while the conduit market in 2017, after adopting risk retention, is likely to end up close to flat from the previous year. It is likely that the SASB volume could remain strong as many of those transactions are short-term in nature and may need to be refinanced into the CMBS market as interest rates remain low.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

We are seeing some softening in certain markets. For instance, Houston was on our radar prior to Hurricane Harvey as office vacancies in the energy corridor had increased in addition to lower hotel occupancies and higher concessions at higher-end multifamily properties. There are markets where new supply may cause short-term disruptions; this is particularly noteworthy for hotels. Regional malls are something that we are watching very closely especially since last year retailers were quick to make store closure decisions following disappointing holiday sales, and we expect this again in 2018. We notice that some mall operators are making great strides to upgrade their offerings while others are lagging, seemingly awaiting more store closures. Other areas we are paying close attention to are suburban office projects and student housing properties.

James Manzi, Senior Director at S&P Global Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We’re expecting about $85 billion in CMBS issuance next year, which is slightly lower than this year’s total, which we expect to be around $90 billion. Lower CMBS loan maturities are a headwind, while continued activity in the single-borrower space and the potential for more multifamily collateral making its way into conduits are tailwinds.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

With offices taking a leading role in conduits in the 2017 vintage (at around 40 percent of collateral) and being second only to lodging in terms of volume securitized in single borrower deals, we’ll be closely watching performance in that sector. It will be interesting to see if companies (office tenants) choose to use smaller footprints over time, similar to the way retailers have reduced theirs.

Zanda Lynn and Huxley Somerville, Head of U.S. CMBS Business Development and Head of U.S. CMBS at Fitch Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

Zanda Lynn: Our projection for non-agency CMBS is approximately $75 billion for 2018. We expect the slowdown in commercial real estate activity to contribute to a decline in overall volume, though the single-borrower market looks strong.

Are there any property type or regions that you are paying close attention to as we go into the new year? Why?

Huxley Somerville: Hotels, while continuing to perform, are showing signs of slowing revenue growth especially in New York City where new construction is adding to underperformance. We do not believe current revenue levels are sustainable over the longer term.

 Larry Kay and Eric Thompson, Managing Director and Senior Managing Director at KBRA

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

While we are forecasting that CMBS private label issuance will decline from 2017 levels, there is still good support for new issuance as many positive CMBS and CRE underpinnings remain intact. Interest rates are still historically low, CRE provides favorable returns compared to other asset classes, CRE capital flows while slightly down are still strong, and credit performance remains stable. However, a potential market disruptor could be if the market believes that the Federal Reserve’s balance sheet unwinding is taking too much liquidity out of the system; this could trigger a jump in, or more volatile, interest rates. In addition, investors may be more cautious in their CMBS and CRE allocations in 2018 as property values are beginning to feel stretched, and a decline in scheduled maturities may limit refinancing opportunities. As a result, we are forecasting $65 billion of private label issuance in 2018, which could end up being 25 to 30 percent lower than 2017 levels.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

In addition to concerns regarding full-price department stores, in 2018, we will be watching their off-price formats very closely. Chains that report sales with off-price department store offerings include Nordstrom Rack, which just reported fiscal 3Q 2017, and Saks Off Fifth with reported fiscal 2Q 2017 numbers. Both experienced declines in same-store sales performance for each respective quarter and through the nine and six months ending October and July 2017. Declining sales in what has been a high-growth segment leads us to believe there could be sales cannibalization and brand dilution taking place.

Historically, the underlying assertion was that department store retailers would not open off-price stores close to their full-line brand if it cannibalized sales. Based on KBRA’s analysis, which used Nordstrom financial disclosures, the distance between Nordstrom Rack and the retailer’s full-line offerings will increase in the future. Of the existing stores, approximately 42 percent of the off-price locations were situated within five miles of the nearest full-line store—the comparable figure for scheduled openings is just 17 percent. Perhaps this has to do with the availability of real estate. However, it could also signal that the retailer is trying to mitigate the potential for cannibalization and brand dilution.

Lea Overby, Head of CMBS Research and Analytics, Structured Credit Research and Ratings at Morningstar Credit Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We expect 2018 nonagency issuance of $70 billion to $75 billion, down slightly from this year’s full-year total of around $85 billion. We are also likely to see another $100 billion in agency issuance next year. The volume of maturing loans that must be refinanced in 2018 will be far lower than in 2017, and most maturing loans are with portfolio lenders, rather than in CMBS. In fact, only $24 billion in CMBS will mature next year, down from over $80 billion that matured in 2017.

Despite the dip in maturing loan volume, we believe that lending may remain relatively constant. We expect transaction volume to remain steady, and borrowers may prepay loans to get ahead of potential interest rate increases. Also boosting CMBS issuance, conduit lenders may become more competitive with balance sheet lenders because conditions in the capital markets remain favorable with tighter CMBS spreads and low volatility. 

Are there any property types or regions that you are paying close attention to as we go into the New Year? Why?

Even though we believe that talk of the retail apocalypse is overblown, we do have concerns for this sector. We expect to see another round of bankruptcies and store closures after the holiday shopping season, and this will likely result in higher vacancy rates in 2018. We will also be keeping a close eye on grocery-anchored space. We believe this sector will see further consolidation, as Amazon’s purchase of Whole Foods and the U.S. expansion of discounters, such as Aldi and Lidl, affect traditional grocers.  Aside from the retail sector, we are also watching the multifamily and hotel sectors. Both have done extremely well during this economic cycle, but the party might not last too much longer. We are seeing signs of overbuilding in certain markets, which may leave multifamily properties and hotels more vulnerable to changes in the economic cycle. There are indications that the stable economy may at last be leading to rising homeownership rates, which may hurt apartment performance. On the other hand, the hotel sector is always vulnerable to economic downturns, and this is exacerbated by increased supply.

Keith Banhazl, Managing Director, Moody’s Investors Service

What does 2018 hold in store for CMBS?

The credit quality of newly originated and outstanding commercial mortgage-backed securities conduit and fusion loans will remain steady in 2018. Rising interest rates and a cyclical inflection point in the commercial real estate cycle pose some challenges to CMBS collateral performance, but declining leverage and increasing coverage in conduit loans provide some degree of protection. Further, the wave of maturing and aggressively underwritten loans from the 2006 and 2007 vintages has mostly come and gone, and we expect the overall delinquency rate to improve as the volume of newly issued CMBS 2.0 loans outweighs that of delinquent CMBS 1.0 loans.