The US is leading the CMBS recovery, with a significant increase in activity this year, while larger, more complex multi-borrower structures are making a comeback. Lynn Strongin Dodds reports

Although the US commercial mortgaged-backed securities market (CMBS) is a shadow of its former self, the market has shown signs of sustained recovery over the past year. Few believe that it will ever return to the boom days but market participants do think it could be an alternative source of financing. The difference this time is that while deals are becoming more complex they are still simpler and easier to understand than those issued before the financial crisis.

Driving growth in the US are the slowing pace of delinquencies, increasing property sales, loan modifications, as well as an improved picture for commercial real estate. As Brian Stoffers, president of CBRE's Capital Markets, says: "The market is definitely recovering although it is still way down from its peak of four years ago which saw around $230bn (€155bn) of issuance. One of the reasons is investors are searching for higher returns in the current low-interest environment and the CMBS risk-adjusted yields are relatively attractive over US Treasuries. The market is split between new origination and refinancing of old deals."

CMBS has also gone back to its roots as a financing tool. Dave Twardock, president of Prudential Mortgage Capital, says: "Between 1995 and 2007, CMBS and the balance sheets of banks were the main sources of new capital for commercial real estate debt. After the financial crisis, the CMBS market became almost non-existent, but there has been a resurgence because the balance sheet lenders don't have enough capacity to handle the entire market. The CMBS market is providing a broader array of financing."

As the recent report by Standard & Poor's points out, the seeds of a rebirth were sown l5 months ago with three single-borrower transactions with relatively simple structures in late 2009. They were all backed by multiple commercial properties but collateralised with a single loan. The main characteristics were extremely low leverage and strong debt service coverage ratios. In addition, bond classes averaged only four, and deal sizes were clustered around the relatively small $450m mark.

The pace has picked up in the first quarter of this year, with $8.7bn of issuance. Estimates are that the US market might pass last year's total of $12bn before mid-year and that the final tally for 2011 might be around $50bn. The most recent deals have been larger and more complex multi-borrower transactions with an average of nine or 10 tranches. For example, the three $1.2bn-plus conduit/fusion deals in February included an average of 10 principal and interest bonds and two interest-only classes. Compared with late-2009 issuances, the newer multi-borrower deals have higher leverage, less debt service coverage, and somewhat looser underwriting.

Average deal sizes have jumped from $769.3m last year to $1.67bn so far this year. However, it is still a far cry from those transactions in 2007 when the average size was $3.19bn. The latest are more similar to the 2004 and 2005 transactions, which averaged $1.25bn and $2.15bn respectively, whereas last year's average was closest to those issued in 1996.

Twardock says: "I do not think we will get back to the 2007 levels, which were driven by big public to private equity deals. I think it also might be a push to reach the $50bn mark that some have predicted for this year. The big unknown is the stability of the global economy and the disruptions to the capital markets because they get nervous when unexpected events happen. If the economy and markets continue to be relatively stable, there will be growth in the CMBS market."

The CMBS market in Europe is about a fifth of the size of the $855bn US market. There are rumours that a Blackstone deal worth £360m (€400m) could revive the market from its moribund state although so far nothing more concrete has emerged. The talk is that the new mortgage bond will be used to fund the private equity giant's £480m purchase of the Chiswick Park business estate in London.

The majority of deals so far, such as the five issues from Tesco arranged by Goldman Sachs since June 2009 - the most recent in February 2011 - have been sale and leaseback transactions allowing the issuer to monetise its operational real estate. The transactions were not seen as true CMBS because investors were exposed to the credit risk of the supermarket chain rather than the valuation risk on the underlying properties.

One of the reasons that Europe is lagging behind is historical. The US banks did not like real estate lending for maturities over five years, so CMBS conduits were established in the 1990s to provide long-term financing via the capital markets. The collapse of the savings and loans business in the latter part of the decade only accelerated its growth. By contrast, Europe moved away from single-borrower placements to the capital markets only around seven years ago, leading to more aggressive loan-to-value ratios at the peak of the boom.

In addition, the investor base for CMBS in Europe is also less developed than in the US, and was more reliant on leveraged buyers such as structured investment vehicles and asset-backed commercial backed conduits. In fact, industry reports show that at the market peak, only 25% of investors in UK CMBS were real money funds.

Emmanuel Verhoosel, head of Europe, Americas and structured products for ING Real Estate Finance, says: "There are key structural differences for CMBS between the US and Europe. For example, in the secondary market the discount in prices is higher, partly due to the lack of transparency and liquidity compared with the US. As a result, the sector is not attracting many investors. Also, the CMBS market in Europe is not as developed and bank finance is currently cheaper. I do think though that the recovery in the US will slowly feed through. This will make European investor more confident and help the market recover."