Reinvigorated US CMBS set to carry momentum into 2025

After spending most of the previous year being beaten up by gloomy headlines, US CMBS enjoyed a comeback year in 2024.

Lifted by growing recognition that not all commercial real estate is bad, by November 22 private label issuance was already at $98.5bn, according to Finsight — already more than double 2023’s full year volumes of $43.2bn and making for the biggest year since 2021.

Paul Staples, director of CMBS capital markets and trading at Academy Securities, says 2024 marked the restart of a “virtuous cycle” of issuance.

“Usually, it takes some outside event like lower rates to get it moving again,” he adds.

Bankers say the turning point was the US Federal Reserve’s dovish shift in October 2023, triggering a rally in US rates and an improvement in secondary as BBB- rated CMBS bonds rallied to about 750bp by early November — more than 300bp inside where they started the year.

This improvement laid “the groundwork for 2024’s market improvements and predictability”, says Leland Bunch, managing director of real estate structured finance at Bank of America.

Single asset single borrower (SASB) issuers bounced back the strongest, with the segment accounting for more CMBS issuance than ever before — at 61.5% of private label issuance by late November.

At the same time, conduit issuance, which Bunch describes as the “bread and butter” of CMBS, was relatively light because rates remained elevated, although Bunch thinks the sector will pick up steam.

However, although Edward Shugrue, CMBS portfolio manager at RiverPark Funds, also sees 2024 as the “year of the Fed”, he also argues it was one of a “new norm” being established as participants became accustomed to higher expected special servicing and default situations.

Greater comfort with the credit risk in deals was another key factor for the CMBS market fully reopening, as subordinated and mezzanine paper rallied strongly.

“With rates stable and more likely to go down than up, the CMBS market should be in a good place,” says Will Goldsmith, head of CRE and CMBS at Medalist Partners. “Some of the easy money has been made, but CMBS still provides opportunities for strong total returns.”

As investors become more confident with the asset class, they could also become increasingly comfortable in venturing further down the capital stack.

“I could see people becoming more aggressive on credit,” Staples says. “This year’s spread compression creates some need to move lower down the stack.”

Staples adds that properties away from office — and, to a lesser extent, retail — remained more heavily in favour in 2024. But he notes that the market did prove that it could finance even these two more beleaguered sectors — although the deals from office or retail that issuers did manage to price were of high quality.

“Everything has been down the middle, with standard clean profiles,” he says.

“We were coming from little new issuance in 2023. This ‘vanilla’ type of issuance is what it takes to get the market going again.”

With this foundation set, there is high confidence that CMBS can build strongly in 2025. For one thing, it should still offer highly attractive returns.

Such was the negativity around CMBS throughout 2023 that the mere mention of the asset class was enough to put off certain allocators. But at some point investors simply could not fail to be lured by the relative value on offer.

“Our view was that CMBS was cheap [amid] the rates and regional banks narrative, as well as the office issues,” says Jose Pluto, portfolio manager at Neuberger Berman. “We think that these narratives in CMBS were bringing down the whole sector.

“That thesis has played itself out as we expected, as CMBS has had one of the best performing years post-GFC. For us, CMBS continues to be a sizeable overweight and drive total returns.”

A November 5 note from Deutsche Bank said that CMBS was showing year-to-date excess returns of 3.6% — its best year in a decade and double the figure for 2023. Single-A rated bonds have returned 13.6%, while triple-B rated paper has returned 21%.

With US investment grade corporate bond spreads at 20 year tights, Deutsche Bank said it expects CMBS outperformance to continue.

“Overall, in CMBS we are comfortable with the credit, are overweight the sector and open to add more deals that we think offer value,” says Zachary Aronson, director and portfolio manager of structured products at MacKay Shields.

“In 2024, people began to expect that interest rates will not go up any more, and this stability in rates has allowed pricing discovery in real estate.”

Rate stability, Aronson adds, makes it easier to determine cap rates and estimate fair value on deals.

“Demand has steadily elevated to absorb the supply and has even exceeded available supply,” says Shugrue.

Indeed, there is reason for dealmaking to also step up another notch.

“Pricing continues to hold in well or even grind tighter,” Aronson says. “I think issuers will take that as a sign to bring more.”

Staples at Academy backs up this point.

“I would expect demand to continue,” he says. “Borrowers still have properties to refinance, and the markets are open.”

Even though US Treasuries began to sell off again in October, CMBS investors appear sanguine about the macroeconomic environment.

“Inflation’s trajectory is heading lower, the economy remains healthy and the direction of monetary policy should support CMBS,” Goldsmith at Medalist says.

Risk assets in the US reacted extremely strongly to Donald Trump’s victory in November’s presidential election, though what it means for inflation and the path of monetary policy is less clear. But there is still confidence that the possibility of a faster growing economy should benefit CMBS.

“I think some people are trying to add risk to their portfolios now with a pro-growth outlook,” Pluto says. “They feel better about growth and fundamentals.”

Moreover, if rates can regain their footing, the market could see more acquisition-driven activity.

“Looking ahead, 2025 is the year when we will also see more acquisitions because of rates stabilising and potentially coming down,” Bunch at BofA says. “Historically, CMBS has been 40% acquisitions and 60% refinancing, but right now it is closer to about 5%-10% acquisitions, and 90% refinancing.”

More market activity could also happen in the multifamily sector, Bunch says.

“A significant number of asset purchases in 2020 and notably 2021, which were typically financed with five-year loans, will be maturing in the near term and should provide CMBS financing opportunities,” he adds.

There is further confidence in fundamentals because, as Goldsmith points out, potential negative headlines — such as structural headwinds in the office sector or the repricing of multifamily properties — are already priced in.

“Any kind of loss or [appraisal reduction amount] coming out now is pretty well telegraphed, even if the magnitude is not certain,” he says.

In fact, Goldsmith thinks certain CMBS capital structures trading at stressed levels could even “surprise people to the upside”.

Staples says there is “a lot of analytical work going on” as investors “continue to refine their credit views of the market and pick their spots, rather than [just saying] ‘I am buying [a particular] vintage.’

“Usually that is because participants are seeking to avoid pitfalls.”

Although maturity wall talk has continued to garner headlines, the market has been gradually chipping away. Of the $49bn of conduit maturities due in 2025, $9bn is already defeased, Deutsche Bank says.

Some of the loans that have been able to push out maturities during the tougher markets may finally have to be refinanced in the market next year.

“Borrowers have extended for a few years while rates were high — and there are only so many levers left that they can pull,” Staples says. “The markets are open, debt costs are higher, and the market has started to accept that as the new normal.”

After a period of being the sick patient in securitization, CMBS is full of cheer.

“We expect to see increased year-on-year issuance and continued spread contraction,” Shugrue says. “That signals a healthy market for issuers, investors, and borrowers alike.”