PERSON OF THE WEEK: Richard Walter Discusses CMBS, Credit Crunch

This week, MortgageOrb spoke with Richard Walter, president of Faris Lee Investments, a retail investment advisory and brokerage firm based in Irvine, Calif. With a new year just around the corner and the crisis in subprime residential continuing to unfold, Walter provided up-to-the-minute observations of the related complications occurring elsewhere – namely, in commercial real estate financing changes, investor sentiment and the uncertain forecast for both crucial consumer spending and the entire U.S. economy.

Q: Much has been said about the relationship between subprime residential and the recent fallout in the commercial mortgage-backed securities (CMBS) and capital markets sectors. How strong is the actual link between the residential and commercial sides of lending? Is there just a loss of investor confidence or deeper issues at work here? Is CMBS ‘the new subprime,’ as some have suggested?

Walter: There is a relationship between subprime residential and CMBS: Many of the investors in the unrated pieces of these loans buy and own both residential and commercial.

As a result, the subprime meltdown has affected marketability of the CMBS product severely. The value of these products has declined due to the illiquidity of the overall mortgage-backed securities marketplace.

However, the major distinction between the products is that CMBS fundamentals are virtually unaffected. There are few or no defaults on CMBS paper, vacancy factors are low and the underlying collateral (commercial property) is a cashflow investment, so without huge tenant default, the collateral is very good. Residential values are falling, and therefore, the collateral on subprime is greatly impaired.

Q: Who is still able to still get commercial mortgage transactions done these days? What specifically separates the winners from the losers in the current climate? Do you expect more winners or more losers in the months to come?

Walter: Banks and life insurance companies dominate the current deals on the table. Some investment banks that did not own a lot of collerateralized debt obligations or CMBS on book will still do deals, but they will do so cautiously – and at spreads which may not work for current deals.

Banks offer great flexibility, and even though they may not be as competitive on terms, they also offer the ability to re-craft the financing during the term, which most CMBS loans cannot do.

Q: Your firm mentions the availability of loans that aim – in particular – to protect against economic shifts and other occurrences. What kinds of features might be in these loans? How have these aims been challenged recently, and have you used any new strategies in response?

Walter: Because every situation is different, the features in these loans vary greatly. We are still providing interest-only features for up to five years – which allows the borrower to maximize cashflow and protect against potential vacancies that may occur.

More important are terms that allow borrowers to move tenants around and create value with new pads, expansion of existing tenant space, renovations or capital improvements. Adding value to retail is very opportunistic: As retailers change their concepts, new space or modified space can be created and rents can be increased.

Because timing is an issue today – with the market moving erratically – one new strategy we have been implementing includes structuring release provisions for future pads – even where the lot lines have not been secured. This strategy allows us to close loans quickly rather than wait for long processes for municipal approvals.

Q: Looking at your target sector of retail, how resilient is the average consumer? Do investors in retail properties feel confident consumers will keep spending? Furthermore, what role does the overall direction of the U.S. economy play in where retail goes?

Walter: We believe that the consumer is resilient. Consumers will continue to spend. Some sectors can be more volatile, like those big-ticket products that require large investments, such as motor homes and boats.

Traditional retail properties, however, will survive very well, as consumers require many of the products offered: food, personal care services, restaurants and so on.

Lack of home equity loans and declining home values will have some effect on retail, but well and densely located properties will thrive. Shop rents will likely flatten, and larger credit tenants will not likely expand as rapidly in growth areas where homes are on hold.

At the same time, the economy is very global, and we are working with investors coming from Europe and Asia who are taking advantage of the value benefit from our weaker dollar versus the Euro.

Q: Crystal ball predictions: Given all the numbers coming in, do you think a recession is in store for 2008? How do investors – especially investors in mortgage-backed securities – feel?

Walter: We don't see a recession in 2008. Many economists are forecasting both sides to this issue, but overall, we have found that investors are very happy with their positions in retail properties.

Buyers are still aggressively seeking these assets – because there is no real alternative to retail, where they enjoy triple-net leases, ease of management, depreciation and tax benefits, with the ability to exchange and defer taxes long-term.

The stock market is too volatile for the typical investors. They prefer to own assets they can touch and feel.


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