Investors eye first commercial real estate CDO of 2013

ew York-based Arbor Realty Trust came to market Wednesday with 2013’s first commercial real estate CDO, a risky derivatives product closely associated with the 2007 financial crisis.

The complex product, known as a collateralized debt obligation (CDO), has been on the rebound since late last year, despite its role in the global financial meltdown.

In a sign of the residual uneasiness over such CDOs, Arbor has avoided calling it that in marketing materials. But four rating agency analysts told IFR the deal is a CDO in everything but name.

Arbor, a real-estate investment trust (REIT), is offering US$260m of the securities, which repackage loans for commercial real estate properties in Detroit and suburban Dallas.

Securitization experts say the offering is backed by first-lien bridge loans of the type prevalent in similar deals before the onset of the last financial crisis.

In addition, the properties in question are known in the industry as “transitional” — that is, even though they provide the cash flows underpinning the deal, they are less than fully rented or are still being redeveloped.

Despite already coming to market, the Arbor deal only has 80% of the expected real-estate portfolio needed to underpin it, according to deal documents seen by IFR.

Because of the Federal Reserve’s current policy of maintaining low interest rates, investors have been increasingly looking to riskier investment vehicles for a better return.

Commercial real estate CDOs like the Arbor deal effectively died out after the last global crisis, but re-emerged last year to be marketed to yield-hungry investors.

The CDOs essentially provide loans to developers of the relevant properties, but went awry during the crisis as many of the loans supporting them went bad.

“Some of the riskier CRE CDOs… proved to perform very poorly,” said Richard Hill, the head of CMBS strategy at RBS.

“At least for basic CDOs of whole loans, there is a use for the product — to provide transitional loans to companies that own properties.”

Around US$1bn in commercial real estate CDOs were marketed in the second half of 2012, including a US$125m deal from Arbor also based on transitional properties.

And RBS analysts estimate between US$5bn and US$10bn in commercial real estate CDO issuance for 2013.

One of the risky elements of the new deal is that it has a two-year reinvestment period, during which the issuer can remove or add loans from the underlying collateral asset pool.

Such so-called actively managed deals are considered to be riskier than static deals, in which investors can evaluate all the collateral ahead of time with no fear of it changing.

The new Arbor deal being marketed to investors consists of a US$156m senior tranche, a US$21m mezzanine tranche, and a tranche of US$83m in preferred shares.

Moody’s is expected to give the senior tranche a triple-A rating and the mezzanine tranche a Baa2.

The collateral includes a US$30m first-mortgage acquisition loan on two high-rise apartment towers in Detroit called Riverfront. The 543-unit towers have a stabilised appraised value of US$51.7m.

The deal also includes a US$12m loan on a recently renovated property, the Edentree Apartments, in a Dallas suburb.

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