The CMBS Shakeout that will Redefine Lending

Fast, short-term money could be on the way out under new risk- retention rules to come into force in late 2016, while more patient debt capital structures could win the day, says Cornerstone’s high-yield debt CIO Jamie Henderson.

Longer-term lenders are poised to gain from a shakeout in commercial real estate finance as the industry confronts new risk-retention rules.

Jamie Henderson, chief investment officer of Cornerstone Real Estate Advisers’ Alternative Investments Group, says new rules that force CMBS issuers or B-piece players to retain a five-percent slice of each deal they issue will change the composition of the entire lending marketplace—and will likely force “leveraged, short-term money [such as hedge funds] out of this game.”

The CMBS risk-retention rules, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act that go into effect in December 2016, not only force those players to retain part of the deal’s market value—much more than what B-piece players buy today—but also require the issuer or nominee to hold the investment for at least five years.

As a result, yields of CMBS—a significant source of mortgage liquidity for middle-market properties in secondary and tertiary locations—are expected to increase, thereby pushing up loan prices.

“Will the industry solve [the challenges ahead]? Yes,” Henderson says. “Will it change the composition of the players in it? In my opinion, yes. The leveraged, short-term money [such as hedge funds] will most likely be out of this game. Maybe not entirely, but my sense is [we will need lenders/investors with a] more patient capital framework.”

Henderson, who oversees Cornerstone’s high-yield debt group and expects to originate up to $3B of loans, including bridge loans and development mezzanine financing, in 2016, says disruption from regulations are not just impacting the world of CMBS—it is also creating opportunities across the real estate lending market.

“The regulatory framework is having a very big impact on the banks and the CMBS lenders. Banks face a lot of regulatory pressure and pressure on their return on equity model,” says Henderson. “The banks will still represent a massive share of the industry’s origination capacity but they will be competing for lower leverage business.”

That means turbulence ahead for the wider commercial real estate lending market, he says. And that’s where debt funds, which are designed to flow through that turbulence, come in.

“Having some volatility in the market is healthy because when markets are steady state, you don’t get paid adequately for risk,” Henderson says. “What no one wants is extreme volatility.”

Despite volatility in the lending markets today, Henderson says real estate fundamentals remain “very healthy” with new supply in check at less than two percent of inventory. “Our sentiment is this is going to be an attractive time to be a lender with a broad-base of capital.”