2010 time to originate new mortgages

Real estate debt investors looking for the best risk-adjusted returns should eye new mortgage originations in 2010, according to a study by property services firm Richard Ellis.

With credit markets still severely constrained, CBRE said there was a “compelling” case for new originations, with lenders able to achieve “excellent pricing on deals that are underwritten on much more conservative terms”.

Comparing a hypothetical 2007 deal with one originated in late 2009, CBRE said not only would the expected default rate on the 2009 mortgage be more than 50 percent less than that seen in 2007 but any potential loss from the deal would be slashed by two-thirds. [See panel below].

With a “dramatic change in underwriting standards”, including lower cap rates, lower rental assumptions, lower loan-to-value ratios and debt yield measures of around 10 percent to 12 percent, CBRE said there was “a compelling opportunity to originate new mortgage loans”.

Combined with expectations occupancy and rent levels in most property types could bottom out by late 2010 in the US – and backed by a study showing loans originated in the real estate bust of 1991 and 1992 were the best performing vintages in terms of defaults – CBRE said there was “significant evidence” whole loans originated today were likely to be “superior, offing investors high risk-adjusted yields”.

A Case for New Loan Originations: Comparing Potential Office Loan Performance  

In its report, The Upside of the Downturn: Opportunities in the Re-Pricing of Debt, CBRE compared two hypothetical office loans using current assumptions for future rent growth and occupancy. The loans are secured against properties with leases averaging five-year terms and an average lease turnover rate of 20 percent a year. Although both deals faced a challenging outlook for occupancy and rent charges, CBRE concluded the 2009 deal had “substantially lower expected default and loss rates, along with improved loss-adjusted yield metrics”.