The Recession Killed This CRE Financing Tool, But It’s Back And Trading Nearly $20B
Investors have revived a popular pre-recession finance tool.
Commercial real estate collateralized loan obligations, also known as CRE CLOs, have made a dramatic comeback in the last 24 months. Issuance through this financing vehicle is expected to reach $20B this year, an amount not seen since 2007, Bloomberg reports.
CRE CLOs are securitized pools of debt, similar to commercial mortgage-backed securities, but typically last two to three years with the option to extend to four or five years. Comparatively, traditional commercial mortgage bonds have terms of seven to 10 years.
During the recession, these types of investments were known as collateralized debt obligations and were largely considered one of the causes of the financial crisis. Back then, CDOs consisted of high risk B-notes, mezzanine loans, junk bonds and other assets.
Today, CLOs consist of less risky senior mortgage loans, and mortgage REITs tend to keep 20% to 30% of a CLO on their books instead of selling them off to bond investors.
CLOs are also considered less risky this time around because they are largely made up of first mortgages, and issuers are required to hold onto a piece of the CLO to have more at stake in case of default.
Some experts have warned that CLOs are still just as risky, that they aren't heavily regulated and that rating agencies are using flawed analysis to grade bonds.
Issuance of CRE CLOs re-emerged in 2011 with a handful of safe mortgages and a stable asset pool. The market gained momentum in the last three years with 13 deals completed in 2015 worth $5.5B and another nine deals worth $2.7B issued in 2016. Deal volume reached nearly $8B in 2017.
This investment has become increasingly popular as interest rates continue to rise and traditional bond prices fall. CRE CLOs offer higher rates of return, more diversity and protection from rising interest rates in return for the investor taking on the default risk.
CLOs can be used for transitional and sometimes riskier assets, specifically when it comes to multifamily assets and other properties that don’t always qualify for traditional lending, including suburban office and malls in transition.
CLOs also are being used in multifamily to bundle bridge loans, which are short-term loans used while a project is securing long-term financing. Projects needing upgrades or experiencing vacancies have typically used these bridge loans.
With more money chasing fewer commercial real estate deals, competition has increased in the lending market between alternative nonbank lenders, traditional banks and CMBS conduits, as they all search for ways to offer cheaper financing.
As demand for CRE CLOs rise, that form of lending has become cheaper than lines of credit or traditional lending for issuers, and more real estate investment trusts and nonbank lenders have been willing to lend through this tool.
Some big names have already capitalized on the re-emergence of this financing vehicle. Blackstone issued a $1B CRE CLO in December, the largest transaction of this type since 2007. The investment, which was collateralized by 31 senior participants, was backed by some high-quality properties.
Greystone, Hunt Mortgage and small REITs and debt funds such as LoanCore Capital and Money360 also have entered the market.