David Nass, Head of Real Estate Finance, UBS Investment Bank
Q: What are you currently working on?
A: Today, it's a combination of asset management for some of our legacy loans, securitizing some of the CMBS loans that were originated pre-COVID while originating new CMBS loans for securitization, and lastly, originating new loans for the balance sheet. We recently priced a deal where we sold $195 million of our collateral into a securitization along with other loans sellers – the collateral in that transaction was a combination of pre-COVID loans and newly originated loans.
In addition to managing the business today, we are focused on growing our commercial real estate direct lending business for our balance sheet and our real estate warehouse book. This effort will result in a larger footprint in offering institutional and wealth management clients traditional floating rate balance sheet loans and will expand our loan-on-loan facilities for aggregators of conduit and transitional commercial real estate loans.
Q: As far as CMBS, are you originating any SASB loans, or are they all conduit?
A: We are more focused on conduit than SASB. In a typical year, we will do one or two SASB transactions. In this unusual year, we have only been involved in conduit securitizations. We are focusing on originating primarily non-retail and non-hotel loans. We are looking at the asset classes that are financeable in the current environment and assets that have current cashflows that has been less impacted by COVID.
Q: Tell us about your warehouse business.
A: We have been active in the warehouse space over the past several years. We are now at a point where we want to expand a successful business. Our counterparties are offered three to five year facilities, with 75% to 80% advance rates on loans that are up to a 75% LTV. We will continue to invest in this business as we see an opportunity to provide more financing to strategic partners of the firm based on a couple of reasons.
One, it is a good credit product for the firm because you have protections like partial recourse and transparency regarding the performance of the underlying collateral and regular reporting of that performance. The advance rate is reasonable against a reasonable loan-to-value, so the exposure is defensible at the end of the day.
Additionally, we think that in today's climate, there's a need for our counterparties to provide transitional financing to their clients. We believe that the pricing and structure in today's lending environment adequately addresses the property cash flow volatility and that we can offer counterparties a solid levered return on the loans that they're originating and funding. We also believe that there is strong demand for CRE CLO issuance and we look forward to continuing to provide our counterparties access to the capital markets and to providing our clients in the investment community with well-structured securities backed by good credit.
Q: What types of loans will you consider for the balance sheet?
A: The balance sheet is more tailored to our wealth management clients. UBS is one of the largest global wealth management companies and many of our wealth management clients have commercial real estate exposure. Therefore, the real estate finance business at UBS is an excellent product group for our wealth management team and offers crossover opportunities for the investment bank to work closely with the wealth management business. Our focus will be to continue provide relationship fixed and floating rate loans ranging from small balance loans with an average loan size of about $10 million and larger balance loans with an average loan size of $50 million.
Our focus is on multifamily, industrial, office, and self-storage property types. At the moment, we are avoiding hotels and retail unless they are grocery-anchored.
Q: Are you willing to lend on suburban office buildings?
A: Yes. My personal view is that we're at this point when we're redefining what primary, secondary and tertiary markets are and what a tier one, tier two, and tier three lending market might be because of the change in demand caused by the pandemic. For example, there is a question as to how occupiers will use their space moving forward and how much permanent space they will need in what has typically been defined as a primary tier one market such as CBD in Manhattan. We have all learned during this pandemic that, at times, you can be just as connected remotely, either with colleagues in a suburban office property or at home using tools such as Zoom, Skype, and other video conferencing software. So, I believe that we're going to see leasing activity for suburban office pickup as companies diversify away from CBD primary markets. And the work from home concept will have an impact on demand – this new way to work will also be part of a lot of occupiers’ business plans going forward. We will learn a lot more as we see new leases executed in CBD and Suburban markets and learn how companies are migrating and modifying their business plans.
Q: Discuss how technology is accelerating the trend of companies relocating their offices to secondary and tertiary markets.
A: Technology is having an impact and creates more flexibility as to where companies and occupiers need to be. I think that it ultimately benefits the employees and users and creates more efficiencies than we thought was possible before COVID.
Q: Given the current market uncertainty, how are you structuring loans?
A: We will continue to offer fixed and floating rate loans ranging in term from 3 to 10 years and we will continue to originate for our balance sheet as well as for securitization. As you would expect, terms are less aggressive during this period of time of more uncertainty. For example, leverage has decreased by about 5% and there is less IO available at the same leverage points prior to the pandemic.
As far as reserves and structure, it is more common post pandemic to see more highly structured loans with debt service reserves for properties that are exposed to tenants that are sensitive to COVID related cash flow disruption. For retail, certain tenants may be asking for forbearance or a modified lease, so you'll need to structure around the rent roll volatility. We recently wrote a loan on a grocery-anchored property on the West Coast. Although the property was in a strong market and the credit story was solid, we required a 12-month debt service reserve in order to fund that loan.
Q: Going back to CMBS, are you witnessing an increase in demand? How is pricing?
A: Since mid-March, we saw spreads in the secondary market go from swaps plus mid 80's to as wide as swaps plus high 200's to low 300's on the last cash flow. We saw a very dislocated and illiquid market in late March. Since then, we have seen spreads retrace most of that, with deals pricing in the low one-hundreds new issue and potentially a deal on the market currently pricing in the high nineties – almost a complete retracement for the triple-A CMBS spreads. However, down in credit, the curve is steeper than pre-COVID, meaning that the subordinate bonds are still wider than they were pre-COVID. I think the pricing for the subordinate bonds reflects the uncertainty in the legacy market with billions of loans being transferred to special servicing and how those subordinate bonds are going to perform.
Q: How do you envision the repositioning of retail, a trend that was already under way pre-COVID? For example, do you have any thoughts on what enclosed malls might look like in 12-18 months?
A: I see it as experiential. That was a common term pre-COVID and I believe it will be relevant in the future. There will be a vaccine, and people will be shopping again. We want to be entertained and we want to be with other people. However, as we've learned during COVID to utilize technology to create efficiencies in order to stay relevant with clients, I think technology will continue to disrupt the retail industry. We will continue to order more on Amazon and have bulky grocery store products sent home rather than going to the stores. But, at the end of the day, when you feel safe again, you're going to want to go to some stores, and you're going to want to try on clothing, and do things that you can't experience virtually. It's not an all or none, and I think the retail industry will continue to be under pressure. The companies/tenants that will survive will be creative and innovative. The strong tenants will also have an online presence. They will make it convenient to return packages either at physical stores or with return labels and packaging, and they will need to figure out an efficient way to restock. They will need to master the supply chain. And that's an additional cost, but that’s not only a cost of just doing business, it's a cost of staying in business as these companies will need to continue to become more efficient and provide improved services to new and existing customers.