(Bloomberg) — An obscure investment product used to finance risky real estate projects is facing unprecedented stress as borrowers struggle to repay loans tied to commercial property ventures.
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Known as commercial real estate collateralized loan obligations, or CRE CLOs, they bundle debt that would usually be seen as too speculative for conventional mortgage-backed securities into bonds of varying risk and return.
In just the last seven months the share of troubled assets held by these niche products has surged four-fold, by one measure, to more than 7.4%. For the hardest hit, delinquency rates are in the double digits. That’s left major players in the $80 billion market rushing to rework loans, while short sellers are ramping up attacks on publicly-traded issuers they say may be so beset by missed payments that they have little to no equity value.
The pain is part of a broader shakeout in the $20 trillion US commercial real estate market, which nearly brought down New York Community Bancorp and has elicited warnings from Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell. Yet industry observers say few products are more exposed than CRE CLOs.
That’s because they’re primarily stuffed full of short-term, floating-rate loans for properties undergoing renovations or expansions, the type of risky debt that banks or CMBS often don’t want to hold. With rising interest rates eroding resale prices for refurbished multifamily dwellings and demand for office space still tepid, many borrowers are starting to struggle to meet their obligations. That’s left a number of CRE CLO issuers — which finance the riskiest part of the structures themselves and sell off the safer pieces — already absorbing losses.
Some say the pain could eventually spread to those invested in less risky portions, too.
“The CRE CLO market is the first shoe to drop in terms of defaults in the CRE debt markets,” said Mark Neely, director of alternative investments at GenTrust, a money manager. “The loans inside CRE CLOs tend to be for transitional properties, so the borrowers are counting on reselling them before the loan matures. But today many borrowers can’t sell properties for anywhere near where they bought them.”
To be sure, the highest rated debt issued by CRE CLOs benefit from ample protection built into the structure of the securities, and analysts across the board expect those bonds to be just fine. At the bottom of the capital stack, however, it’s a different story.
Issuers have been buying time by extending maturities, letting developers pay interest with additional debt, and making other changes to loans to encourage borrowers to keep current.
Modifications often take the form of two- to three-year extensions, in exchange for which borrowers typically are required to inject more capital.
Increasingly, CRE CLO issuers are also buying out delinquent loans via cash reserves, allowing them to avoid tripping asset-coverage tests which causes cash-flow streams to certain investors to get turned off — a mechanism designed to protect those who purchase less risky portions of the structures.
Firms bought back a record $1.3 billion of delinquent loans last year, according to JPMorgan Chase & Co. estimates.
“Increased stress in this market has forced managers to take unprecedented steps to protect the integrity of their CRE CLO structures,” strategists led by Chong Sin wrote in a report last month.
Market watchers say that may partly explain why the share of loans in CRE CLOs with payments more than 30 days overdue fell to 7.4% last month, based on data from analytics firm CRED iQ, after peaking at more than 8.5% in January. Another measure of CRE CLO loan stress from Citigroup Inc. that uses different criteria touched 4.8% in January, the highest in data going back to 2014.
“Incentives in these structures are substantially aligned with bondholders, and there’s a strong motivation for sponsors to buy troubled loans out of the trusts,” said Liza Crawford, co-head of global securitized at TCW Group Inc. Still, she added, “I don’t think everyone is going to have enough money or financing to do that. It’s a ticking clock.”
The origins of CRE CLOs date back to before the financial crisis, when commercial real estate collateralized debt obligations, or CRE CDOs, were a routine financing tool. Demand all but disappeared in 2008 as real estate prices plunged and the downfall of Bear Stearns and Lehman Brothers Holdings Inc. prompted money managers to shun riskier structured credit products.
Modern CRE CLOs, a rebooted version with more investor protections, first came onto the scene in late 2011.
The basic concept is the same. Non-bank lenders create separate entities to hold tens or hundreds of millions of dollars of commercial real estate loans, and investors buy slices of the vehicles in the form of bonds. In exchange, they get a share of the income thrown off by the underlying loans. Cash flows follow a so-called waterfall structure, wherein the most senior bonds get paid first, while the riskiest slice — known as the equity — gets paid last. Any losses in CRE CLOs fall on holders of the most subordinated portions.
CRE CLOs attracted little attention for years. Then in 2021, the pandemic produced the perfect conditions for a surge of issuance. New work-from-home and social distancing norms resulted in more Americans moving into separate households, many of them in the Sunbelt. The result? An unprecedented increase in demand from real estate investors taking out short-term, floating-rate loans to buy apartment buildings, renovate them, and sell them at a profit – a strategy known as “fix and flip.”
Issuance of CRE CLOs leaped from $19 billion in 2019 to $45 billion in 2021, according to data compiled by Bloomberg. As much as 72% of the collateral inside CRE CLOs is backed by multifamily property, with another 13% tied to offices, according to figures from real estate data provider Trepp.
Then the problems began.
When the Federal Reserve started hiking rates, it raised the interest burden for developers that took out floating-rate loans hoping to “flip” properties. Making matters worse, the pandemic-driven surge in apartment demand soon turned into a supply glut that’s still weighing on rents and property prices.
“It was this kind of pig through a python dynamic,” said Neely. “All of this demand came through the system at once, and now we’re feeling the aftermath.”
‘Stress Test’
The share of delinquent loans in CRE CLOs from Arbor Realty Trust Inc., one of the industry’s largest issuers, touched 9.2% in January before sliding back down to 8.1% in February, according to CRED iQ data.
Its share price is down 16% year-to-date after rising 15% in 2023, while about 40% of its floating stock is currently sold short, according to data from analytics firm S3 Partners.
Arbor didn’t respond to requests seeking comment.
Arbor Chief Executive Officer Ivan Kaufman said on the company’s most recent earnings call in mid-February that it is working closely with borrowers to recapitalize deals and is looking to make new loans to keep growing the company’s balance sheet.
At least two CRE CLOs from Ready Capital, another major issuer, have already breached safety triggers, while 15% of its loans have been transferred to workout specialists known special servicers, according to data from Barclays Plc.
A spokesperson for Ready Capital declined to comment.
Just last week four CRE CLO bonds issued by Blackstone Mortgage Trust were downgraded by Morningstar DBRS because of higher expected losses on underlying loans, with the lowest-rated bond tranche cut to CCC. The downgraded bonds belong to a CLO that’s primarily backed by office properties rather than multifamily dwellings.
Short seller Carson Block in December said he was betting against the publicly traded real estate investment trust, predicting that even if the Fed lowers interest rates, losses on its loans could reach well into the billions, wiping out the trust’s equity.
“The credit-rating downgrades reflect challenges in the office sector that are well understood by the market,” a representative for Blackstone said via email, adding that all of Blackstone Mortgage Trust’s CLO bonds are performing and making payments to investors.
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TCW’s Crawford sees continued stress for CRE CLO sponsors in this rate environment.
“What we’re seeing is a major stress test for a market that is relatively young,” said Crawford. Issuers “are really going to have to show their mettle.”
–With assistance from Neil Callanan and Rheaa Rao.
(Updates with latest credit news at bottom of story)
TORONTO – The Toronto Regional Real Estate Board says home sales in October surged as buyers continued moving off the sidelines amid lower interest rates.
The board said 6,658 homes changed hands last month in the Greater Toronto Area, up 44.4 per cent compared with 4,611 in the same month last year. Sales were up 14 per cent from September on a seasonally adjusted basis.
The average selling price was up 1.1 per cent compared with a year earlier at $1,135,215. The composite benchmark price, meant to represent the typical home, was down 3.3 per cent year-over-year.
“While we are still early in the Bank of Canada’s rate cutting cycle, it definitely does appear that an increasing number of buyers moved off the sidelines and back into the marketplace in October,” said TRREB president Jennifer Pearce in a news release.
“The positive affordability picture brought about by lower borrowing costs and relatively flat home prices prompted this improvement in market activity.”
The Bank of Canada has slashed its key interest rate four times since June, including a half-percentage point cut on Oct. 23. The rate now stands at 3.75 per cent, down from the high of five per cent that deterred many would-be buyers from the housing market.
New listings last month totalled 15,328, up 4.3 per cent from a year earlier.
In the City of Toronto, there were 2,509 sales last month, a 37.6 per cent jump from October 2023. Throughout the rest of the GTA, home sales rose 48.9 per cent to 4,149.
The sales uptick is encouraging, said Cameron Forbes, general manager and broker for Re/Max Realtron Realty Inc., who added the figures for October were stronger than he anticipated.
“I thought they’d be up for sure, but not necessarily that much,” said Forbes.
“Obviously, the 50 basis points was certainly a great move in the right direction. I just thought it would take more to get things going.”
He said it shows confidence in the market is returning faster than expected, especially among existing homeowners looking for a new property.
“The average consumer who’s employed and may have been able to get some increases in their wages over the last little bit to make up some ground with inflation, I think they’re confident, so they’re looking in the market.
“The conditions are nice because you’ve got a little more time, you’ve got more choice, you’ve got fewer other buyers to compete against.”
All property types saw more sales in October compared with a year ago throughout the GTA.
Townhouses led the surge with 56.8 per cent more sales, followed by detached homes at 46.6 per cent and semi-detached homes at 44 per cent. There were 33.4 per cent more condos that changed hands year-over-year.
“Market conditions did tighten in October, but there is still a lot of inventory and therefore choice for homebuyers,” said TRREB chief market analyst Jason Mercer.
“This choice will keep home price growth moderate over the next few months. However, as inventory is absorbed and home construction continues to lag population growth, selling price growth will accelerate, likely as we move through the spring of 2025.”
This report by The Canadian Press was first published Nov. 6, 2024.
HALIFAX – A village of tiny homes is set to open next month in a Halifax suburb, the latest project by the provincial government to address homelessness.
Located in Lower Sackville, N.S., the tiny home community will house up to 34 people when the first 26 units open Nov. 4.
Another 35 people are scheduled to move in when construction on another 29 units should be complete in December, under a partnership between the province, the Halifax Regional Municipality, United Way Halifax, The Shaw Group and Dexter Construction.
The province invested $9.4 million to build the village and will contribute $935,000 annually for operating costs.
Residents have been chosen from a list of people experiencing homelessness maintained by the Affordable Housing Association of Nova Scotia.
They will pay rent that is tied to their income for a unit that is fully furnished with a private bathroom, shower and a kitchen equipped with a cooktop, small fridge and microwave.
The Atlantic Community Shelters Society will also provide support to residents, ranging from counselling and mental health supports to employment and educational services.
This report by The Canadian Press was first published Oct. 24, 2024.
Housing affordability is a key issue in the provincial election campaign in British Columbia, particularly in major centres.
Here are some statistics about housing in B.C. from the Canada Mortgage and Housing Corporation’s 2024 Rental Market Report, issued in January, and the B.C. Real Estate Association’s August 2024 report.
Average residential home price in B.C.: $938,500
Average price in greater Vancouver (2024 year to date): $1,304,438
Average price in greater Victoria (2024 year to date): $979,103
Average price in the Okanagan (2024 year to date): $748,015
Average two-bedroom purpose-built rental in Vancouver: $2,181
Average two-bedroom purpose-built rental in Victoria: $1,839
Average two-bedroom purpose-built rental in Canada: $1,359
Rental vacancy rate in Vancouver: 0.9 per cent
How much more do new renters in Vancouver pay compared with renters who have occupied their home for at least a year: 27 per cent
This report by The Canadian Press was first published Oct. 17, 2024.
