Wednesday, November 19, 2008

CMBS: This is no cave...

If you are like many of our readers, you are a bond guy and are well aware that CMBS (commercial mortgage-backed securities) are in an absolute free-fall. If you aren't a bond guy, let me be the first to tell you that the CMBS market is in an absolute free-fall. Here is the chart on the Barclays INVESTMENT GRADE CMBS index month-to-date.

Yes... that -19.61 number? That's a percentage return vs. Treasuries. The whole index down 20% month-to-date. Ugh.

The story is no better for AAA-only bonds. Check out the AAA CMBX spread (higher spread = bad).

Readers may remember that I said AAA CMBX should tighten based on fundamental risk if the credit crisis was improving. That's way back when this index was around 220. Now 550. So I'll go ahead and say the credit crisis isn't improving.

Anyway, this sparked an interesting debate among two colleagues of mine. I argued that if I had to blindly buy a CMBS deal full of hotel projects or retail projects, knowing nothing else about the deal, I'd buy the hotels. Its purely academic, because I actually wouldn't buy either. But its an interesting debate, and I think its one that would extend to REIT stocks as well.

Here's my thinking. I believe that the liquidity crisis is passing, but that we're entering into a severe recession. Economic activity of all types are going to contract, so the question is who is better prepared for such a contraction?

Classically hotels have been viewed as more economically sensitive compared with retail. In a recession, business cut back on travel and consumers cut vacations. But they still keep shopping, even if at a reduced rate. Add in the fact that during the most recent recession, hotels were hit particularly hard, as 9/11 curtailed travel even more than a normal recession.

My conclusion is that the hotel sector might actually outperform the retail sector.

Post your thoughts, and remember death is not an option. You have to go to bed with one of these uglies, which one do you choose? I'm also posting a new poll on the same subject.


Christopher Wheeler said...

AI: I'd place my bet on the hotels. I live in a town that straddles I-40. Due to our location, we have a number of business travel hotels in town. Think Holiday Inn Express, not Sheraton or Hyatt. In 2002, prices for a room were down to $29/night. Last year they were up to $44. Now they are back to $33, and headed lower.

A hotel can cut it's overhead to less than what you have in a strip mall. One desk clerk and a part-time maid is all you need for labor costs. Rooms with no one staying in them don't require much in the way of utilities. In a strip mall, every store needs a sales clerk, plus a lot of working capital tied up in inventory.

In a hotel, you're still in business even with only a few rooms rented. You hunker down and wait for the recession to end. When it does end, you hire a second maid as your capaicty utilization increases.

At the strip mall, the weaker businesses fail. Now you've got an empty storefront. During the next recovery, somebody will eventually rent the property, but you will have to do a build out for the new merchant.

By my lights, the hotels have better survival chances, and can ramp back up faster in the recovery. I think that makes them better risks.

But what do I know. I work in appliance manufacturing.

PNL4LYFE said...

I've got a question about the relative levels of CMBX tranches. From a run this morning, I saw the following levels for CMBX5

Tranche Spread $ Price
AAA 550 68
AJ 1700 33
AA 2050 30
A 2500 30
BBB 3350 25
BBB- 3800 21
BB 4800 16

I realize that there are differences in assumed duration (shorter for low rated tranches) and probably other factors that I'm not aware of. My question is why there isn't a larger dispersion of dollar prices. I would have thought that if the senior tranches were trading at such low levels, the junior ones would be practically worthless. Is it because the payback period is short for the low tranches? Or because of the uncertainty of where the fulcrum will ultimately lie? Thanks in advance for any help.

David Merkel said...

I would go with retail, that's what I was taught as a young analyst -- the four food groups of Commercial Mortgages -- Multifamily, Retail, Office and Industrial are always more stable than operating properties like hotels, which embed more business risk.

After all, who is in better shape, General Growth Properties or Marriott?

Uh, switch my vote to hotels.

Alex Morrow said...

I'd vote for retail. Consumers have closed their wallets based on fear, not necessarily logic. The incessant negative headlines have made a major impact on the psychology of main street.

I believe the change of administrations, with accompanying massive infrastructure spending will result in more positive headlines that restore confidence.

The hotel recovery will come after the consumer starts buying and businesses begin to recover.

Accrued Interest said...

I'm thinking along the lines of Christopher, where a hotel's operations are built to handle severe slowdowns, where as I don't think your typicall mall is. As David points out, GGP is a perfect example.

Unknown said...

i work for a retail REIT--not GGP but one of the three that still trades above $25 per share...GGP is going under due to a non-retail aquisition, Rouse from a couple of years ago. Bad debt is bad debt no matter how you dress it up, and the bad issuance by GGP a few years back has caught up to them. Their malls are still in 'A' locations and tenants are still in business, however, they have zero access to capital [they have property level debt on every asset] and as their NOI falls by a couple of percentage points the whole house collapsed.

Good retail grocery center REITs will always outperform the hotel sector. the post from above indicated that we have to staff every store in a shopping center--lets remember that REITs own the shopping center, and not the business. Small mom and pops are still leasing in 'everyday needs' centers with strong grocers and same center NOI growth is still in the high single digits compared to last year.

Pray for retail, but hotels were vastly overbuilt and with companies cutting back and down for the next several years, watch out for severe pain.

you can find me at WMT if you want to respond.

JM said...

You're underestimating the staff at even a small hotel. Maintenance; guests, in general, are malicious idiots when it comes to shoving stuff down toilets, playing with air conditioners, etc. Round-the-clock coverage at the front desk, not just retail hours (unless you want a complete security nightmare). Plus, checking in and out guests isn't spread out during the day - everyone leaves and shows up at the same time, and one clerk probably can't handle it.

Retail help is making minimum wage; at least way back in the day (I did it as a summer job in college back in the 80s, so not exactly recent experience) hotel desk clerks made significantly more. You're relying on the desk for a fair amount of common-sense things; keep an eye out for illegal activity, don't rent to people who are going to trash the place, last-minute maid/maintenance duties, etc. Minimum wage means, well, good luck on the common-sense bit.

Christopher Wheeler said...

Well, this is kinda fun. I admit I hadn't thought about shopping centers anchored by grocery stores. I was considering the smaller strip malls that have five or six stores without a real anchor to draw traffic.

James sounds like he has some direct experience in the hotel business, so I will defer to his superior knowledge.

David Merkel said...

GGP about to buy the farm? (Without the ag land...)

I'll say one thing, the Rouses' picked a good time to fold their cards.

Shervyn said...

I think Matt's distinction is a legitimate one, but I wonder if even grocery centered retail won't get slammed much harder than expected. The WSJ ran an article recently about Meijers and what it was doing to try and cut costs. If someone like Meijers is running that scared, and Target is getting slammed (even the Target Supers with gorceries), it is going to be much uglier than we think.

But if I had to choose I would still go with power centers anchored by Walmart or Meijers.

Accrued Interest said...


Interesting perspective. I think what Christopher was saying was that retailers themselves have less flexibility and therefore vacancy at malls and shopping centers should go up. That's my line of thinking.

Obviously if you have a shopping center anchored by a grocery store on one end and a Wal Mart on the other, its probably going to perform just fine. But I said you had to pick a retail security at random. So you can't cherry pick a safer retailer vs. a random hotel.

By the way, my office is two blocks from one of Rouse's former star assets. Matt is right, the place has very few vacacies and traffic is strong. At least for now...

Credit Cruncher said...

I am no expert on CMBS, and can't stop myself from making the qualifier that it all depends on the underlying assets, and you could probably find out some info about that, if you were going to make the trade, but aside from all that, I think that I'd go with the retail pool. Generally malls are anchored by major retail chains that still have some access to capital, even today, so that they don't need huge volumes to survive (leverage will go up, but they can keep the lights on, even if they close some stores).

Plus, as someone else said, the lease can be transferred to someone else. So even if your anchor store moves out of that location, they are still responsible for paying the rent (you get two companies on the hook for the price of one, if they can find a replacement tenant).

Plus, grocers would be gold if you could get them (other than one or two that are the exception to the rule).

So yeah, retailers, but it's a close call. I think I agree that a weak hotel is more likely to survive in this environment than a weak retailer. But I do like the idea of an anchor tenant...

David Murphy said...

My vote would be retail, not least because hotel groups tend to be more leveraged, and if the chain goes down, you lose marketing for your property. Sure you still have the asset, but what's generating the cashflow? I'm not a CMBS guy though so take that with a huge pinch of salt.

Accrued Interest said...


I would have guessed retail is more leveraged. Obviously it depends on the situation. I don't trade CMBS much either (have dabbled in GNMA Project Loans which is really not the same at all), so someone correct me if I'm wrong.

Credit Cruncher said...

I think it depends on if you are talking the leverage on the property the company itself or the CMBS structure (the assumptions the rating agencies use would impact the leverage in the CMBS itself, I would guess). I think the comment was with respect to the companies, and I don't for know the answer for sure, but I would have guessed that retailers would be higher rated on average, but I could be wrong (not sure I've ever looked at a hotel chain) and that may not be exactly the same comment as retailers being lower levered...

More grains of salt here than in a salt shaker. ;)

David Murphy said...

Yeah, it was leverage on the hotel company itself. I was thinking of this as a little like servicer risk in more conventional ABS. That is, in say a credit card deal, if the servicer fails and you don't have a hot backup, you lose some of your cashflow because the pool isn't being properly managed. In a CMBS hotel deal if the brand fails, then your hotel is not getting bookings from the website, isn't attracting people with loyalty cards and so on. So regardless of whether 'your' Sheraton as a building is bankruptcy remote from the failure of the HOT, you are still exposed to its performance.

(I do hope you are all impressed at my restraint in resisting a too HOT to handle joke.)

John said...

I'm inclined to believe that "it depends on (1) capacity in the underlying sector, i.e, hotel vis-a-vis retail, and variance from replacement cost that either segment is trading at.

If the retail is currently trading at say -50% from replacement cost (i.e., at 1/2 the price that it would cost to build a new building from scratch) and hotels are trading at -40% of replacement, I'd go with retail and vice versa.

Sorry, always have been and always will be a fundamentals guy. So I'd look at the fundamentals and the widest divergence from fundamentals, as articulated above is the option I'd take.

Matt DK Paradise said...

I think I'll go for the CMBS on the hotels given that these are more likely to default in the near future. This will probably mean that I will have to accept a hair-cut on the investment. However, overall there will be a much better yield to maturity. The proceeds from this initial and defaulted investment may be reinvested at a higher yield. These days bond investors need more default strategies. Think about it. Nice blog.

LHB said...

As an owner of commercial property, I'd go with retail vs. hotels. The income stream on a typical mall or shopping center is supported by 5 to 10 year lease(s) with credit tenants vs. a hotel and its day to day room rentals.

Apolitical said...



crabsofsteel said...

I know CMBS, and I figure that both RT and HT are going to get crushed in the recession, so I would have to look at the deal to see how leveraged the properties were. I would prefer a deal with hotel loans of 25K/key over a mall loan of 400/sq ft, or vice versa if the hotel loan were overleveraged.

jonathan said...

Late to this post, but if the question is a random pick of retail or hotels, I'd say the real question - from years in retail dev. - is the amount of leverage. It's not how your shop vacancy rates climb but whether you meet your loan covenants. Lots of centers won't and there isn't much hope for landing new credit tenants for a while - more of a chance that we'll be losing more, especially junior boxes. Hotels will do worse "objectively" but the question, which I can't answer, is how much leverage exists to cash in that business. If there's more coverage to free cash, there's more slack and the random hotel bunch might then be the best pick.