The CRE CLO market's turnaround is fully underway, with issuers making use of investor demand by extending out reinvestment periods. Now, market participants are hopeful that 2025 will bring significantly improved issuance after a tricky couple of years.
“2024 performance [of CRE CLOs] has given us a lot of confidence,” said Harris Trifon, partner and portfolio manager at Lord Abbett, on an ABS East panel. “More sponsors have been buying out loans, and we have seen green shoots in the new issue environment.”
Triple-A CRE CLO bonds started the year with “incredibly cheap” spreads in the low 200s, but they rallied into the mid-150s, according to Andrew Flick, managing director of CMBS trading at Cantor Fitzgerald, who was speaking on an ABS East panel on Tuesday.
With $7.3bn in CRE CLOs issued already this year, 2024 has already sailed past 2023 volume of $4.8bn. Flick said he expects $15bn-$20bn of CRE CLO issuance next year across 20 to 25 deals, which will be “something our market could handle and would price well”.
Market turnaround
Flick added that he was surprised more issuers were not tapping the market, given the growing demand for CRE CLOs. With investor interest strong, he said there is a case for triple-A rated CRE CLO paper to get as tight as 125bp over Sofr.
It represents a stark turnaround for CRE CLOs. Trifon said a tightening of 100bp or more would have been "unthinkable” just over a year ago.
But market participants are infused with a newfound level of confidence after the Fed's restrictive monetary policy turned the corner.
"After the most extreme bear market for commercial real estate that we’d seen since the GFC,” Trifon said, “there is a sense of confidence and stability that we’ve weathered the storm."
High yield scarcity
CRE CLO issuers who have come to market recently have been able to make the most out of robust investor demand. Issuers have pushed reinvestment periods, which were typically around 18-24 months, all the way out to 36 months.
“As an investor, I’m not a fan,” Trifon said, “but issuers have leverage because there is a lack of high yield senior paper offering 6%-7% coupons.”
Collateral in CRE CLOs typically includes bridge loans used for transitional properties. Investors use CRE CLOs to gain spread pickups relative to other asset classes. Trifon estimated this pickup would be around 15bp.
“CRE CLOs have a lot of good structural enhancement and features other CMBS asset classes don’t have, like more credit enhancement, IC, and OC tests,” he added.