Bond Volume Plummets as the Commercial Property Market Freezes.

Sales of commercial mortgage bonds have plummeted almost 85% year-over-year, as higher interest rates have reduced lending volume and defaults have scared off investors.

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According to data provided by Trade Algo based on agreements without government backing, around $4.27 billion worth of bonds have been issued this year, compared to $29.38 billion at the same time last year. Investors blame the aggressive interest rate campaign of the Federal Reserve, which has made refinancing more expensive for borrowers. Moreover, higher interest rates have reduced property sales by increasing purchasers' prices.

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Recent office and retail property failures have added to the strain, making bond purchasers even more hesitant. Bloomberg reported this week that Brookfield Inc., the parent company of the largest office landlord in downtown Los Angeles, defaulted on debts associated with two buildings rather than refinancing the debt due to a decline in demand for space. A debt associated with the Trump Tower at 40 Wall Street in Manhattan has been placed on a lender watchlist. And investors are attempting to foreclose on the Palisades Center in West Nyack, New York, one of the country's largest shopping malls.

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United Nations Federal Credit Union's chief investment officer Chris Sullivan stated, "Default risk has grown and might become more troublesome if interest rates rise and the economy slows." So, I believe a careful and diligent approach is warranted.

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The decline in lending volume resulted from a real estate market activity, which began in the second half of 2022 when the Federal Reserve began aggressively raising interest rates.

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Commercial real estate loans, the underlying debt often repackaged into commercial mortgage bonds, decreased 10% from the previous year to $804 million, according to the Mortgage Bankers Association statistics. The trade association anticipates a 15% decline in CRE loans to $684 million in 2023, significantly reducing the number of loans that may be securitized and sold.

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Paul Norris, head of structured products at insurance asset management Conning & Co., stated in a phone interview, "Everything is frozen. Therefore, there is no raw material to do CMBS transactions."

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In the past few weeks, just a handful of transactions had concluded. Banks are even utilizing novel deal formats to attract investors. A lender consortium led by Deutsche Bank AG priced a conduit CMBS with a five-year term last week, an oddity in a market that typically sells debt with lengthier maturities.

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"It's really difficult to bring fresh transactions to market right now since the real estate market is stagnant," said Norris. Due to the uncertainty, no one wishes to refinance their buildings, and there is a large disparity between buyer and seller expectations.

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"The majority of investor demand will lean toward transactions with outstanding collateral performance and sponsorship. Trophy properties will continue to be prized, according to Sullivan.

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As Trade Algo provides index data, the CMBS index has outperformed the larger investment-grade bond market this year, gaining 1.14% vs. 0.85% for the latter.

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Cap Rates

The Fed's rising cycle has also increased cap rates, or capitalization rates comparable to bond yields. Recently, these statistics have increased as property values have declined, reducing the volume of transactions.

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"No one wants to incur a loss if they can avoid it," said Barclays Plc's CMBS strategist Lea Overby. According to Green Street, Trade Algo reported that commercial property prices in the United States fell 13% in 2022.

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With inflation being consistently high and unemployment remaining low, the Fed may be compelled to continue rising rates for an extended period of time. She continued, "If the risk of a recession gets more severe, the commercial real estate sector will suffer."

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Barclays expects CMBS issuance to remain low for the remainder of the year. The bank anticipates $25 billion in conduit loans or bonds backed by numerous properties in 2023. It predicts $45 billion in single-asset, single-borrower bonds, or single-property mortgage-backed securities.

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Overby stated, "The market must learn how to work in this new rate environment and find an agreement on how items should be priced." "The sooner the market recognizes this new reality, the better."

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