The nearly $600 billion in outstanding mortgages on income-producing properties has opened to "securitization," according to investment bankers, real estate experts, mortgage bankers and others.
Such securities offer investors two advantages over real estate investment trusts, the traditional means of investing in commercial real estate, according to Cecil E. Sears, a senior associate in real estate finance research at the Urban Land Institute in Washington, D.C.
"One, it's in smaller economic units," he said. "The second advantage is, it's much more liquid since there would be a market and you could sell your shares. It will become a more efficient way of raising debt capital, and that's what will make it go."
Sears said that to become a "functioning market," a rating system involving standardized documentation will have to develop for commercial real estate securities, just as a rating system has developed for corporate bonds.
'New Area of Finance'
Because of lack of a strong investment market, such securities are going to the institutional market rather than to the retail market, he said.
"The commercial securitization process," William T. Clay, manager of Salomon Brothers' real estate resource department in New York, told a recent Mortgage Bankers Assn. conference in Chicago, "is an entirely new area of finance that is now where residential securitization was five years ago.
"The lack of standardization is the only thing holding it back. In residential real estate securities, one Ginnie Mae is like another. But with commercial securities you have to ask credit questions."
Because of the lack of standardization in product type, underwriting, financing, documentation and servicing that exists in the secondary market for residential loans, said Samuel E. Pincich, program director for income property lending with the U.S. League of Savings Institutions, "buyers must spend more time on inspection analysis and underwriting of loan purchases. Sellers must invest more time in packaging loan presentations and in negotiating loan sales."
But rating systems slowly have been developing since November, 1984, when Standard & Poor's introduced a system for rating securities backed by commercial mortgages, which enables investors to compare the risks and rewards of commercial mortgage-backed securities with those of corporate and municipal bonds and other types of investments.
Standard & Poor's has rated for Salomon Brothers issues of $160 million, $200 million and $450 million on three existing Manhattan office buildings, giving each AA ratings, and it has 10 other rating requests, according to Janet Conway, vice president in charge of its commercial mortgage group.
Salomon Brothers has issued even more unrated commercial real estate securities, including a $204.8 million collateralized mortgage obligation (CMO), than rated securities and is currently marketing in denominations no smaller than $1 million, $279 million in securities backed by 24 Holiday Inn properties in 11 states, according to Clay.
Sears said that some commercial real estate securities are already being marketed specifically for IRAs and Keoghs in shares as small as $2,000 to $10,000.
Lenders, who now sell most of their residential mortgages in the secondary market, also want to see the development of commercial real estate securities and a market for them because "income-property loans are the most illiquid loan they can have in their portfolios and a difficult one to sell in the secondary market," according to Dall Bennewitz, a vice president and director of investments and capital acquisition with the U.S. League of Savings Institutions.
"Borrowers," maintains Ronald F. Poe, president of the White Plains, N.Y.-based mortgage banking firm of Dorman & Wilson Inc. and president of the Mortgage Bankers Assn., "desperately want a commercial security because it will bring rates down. In six months to a year you will see a market (for commercial real estate securities) begin to develop and grow and grow."