Commercial real estate was one of the scariest assets in the US last year. This year, investors are warming to it once again – and that’s helped revive a key property debt market. 

Investors have snapped up about US$24.6 billion of new commercial mortgage backed securities (CMBS) so far in 2024, 170 per cent more than the same period in 2023, according to data compiled by Bloomberg News. Spreads on the riskiest portions of CMBS deals have been among the top performers compared to other widely traded types of credit.

When lightning-quick bankruptcies felled several regional lenders last year and interest rates seemed on an endless march higher, the commercial-property market all but ground to a halt. CMBS issuance plunged, and spreads blew out. 

Now those fears are receding. A once-frozen market for office towers is seeing deals again, and major real estate investors including Blackstone are greenlighting big investments in a sign that they believe property markets have begun to rebound. Add to that a Federal Reserve that’s signalled the end of rate increases – notwithstanding recent suggestions of a longer-than-expected timeline for cuts – and investors are once again ready to dive into new issues.

“Investors have warmed significantly to commercial real estate this year,” said TJ Durkin, head of structured credit and speciality finance at TPG Angelo Gordon. “It’s much different than the fear that characterised last year.”

Among the highlights this year are a US$2.35 billion CMBS issued by Blackstone. That deal, which priced in March, is backed by a portfolio of 186 industrial properties across 11 states.

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For CMBS buyers, the difference between this year and last is that they’re no longer applying blanket assumptions to the sector, said Morris Chen, a portfolio manager at DoubleLine Group. Instead, they’re “sharpening their pencils”, looking for value on a deal-by-deal basis. 

“Back then, the market was overly bearish, thinking about the worst possible outcome,” said Chen. “It began to look beat up compared to other asset classes. That’s brought investors back in.” 

Demand for deals has driven spreads tighter, with CMBS bonds rated BBB- shrinking more than 250 basis points from a year ago, according to Citigroup data as at Apr 22. Only private residential mortgage backed securities and some of the riskiest collateralised loan tranches have done better, while investment-grade and high-yield corporate debt, asset-backed bonds and agency borrowing haven’t narrowed as much. 

Those tighter spreads in turn are helping draw in more borrowers.

“Borrowers have been holding out for an opportunity to refinance debt with short-term maturities and now they’re seizing on lower spreads to do it,” said Raviv Shtaingos, head of structured credit at Orix Corporation USA.

Much of the shift in sentiment has occurred over the past few months, as a consensus developed that the Fed’s next move will be to lower interest rates. That’s good news for the bond investors and real estate owners – and issuers – who had been waiting for clarity on the end of the hikes. 

“People have been listening to the Fed and looking at economic data and concluding, ‘Rates are coming down or stabilising, now is a good time to do deals,’” said Paul Staples, a trader at Academy Securities.

To be sure, the gloom hasn’t entirely lifted. There’s still a long way to go to refinance a CMBS maturity wall that stood at US$210 billion at the end of last year. And as long as interest rates remain above the super-low levels many borrowers locked in during the pandemic, valuation drops will continue to ripple through property markets as “cap rates” – a key metric used to price commercial real estate – adjust upwards.

In recent weeks, of course, hot inflation data has upended some of that certainty about the Fed’s interest rate plans. Policymakers will meet this week and traders will parse Chair Jerome Powell’s comments for clues about the latest thinking around easing policy. 

But perhaps surprisingly, a higher-for-longer rate outlook may actually help lift CMBS issuance levels for the remainder of the year, according to a note by Bank of America strategists Alan Todd and Henry Brooks recently. The bank revised upwards its issuance forecast for CMBS by 20 per cent to US$90 billion for the year. That would put this year’s issuance in line with the US$91 billion average for the last eight years, according to Bloomberg data. 

“A greater number of borrowers may simply decide to ‘bite the bullet’ if it begins to look like rates are unlikely to fall anytime soon,” they wrote.   BLOOMBERG