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Chikolwa, Bwembya (2010) Dislodgement of commercial property public debt
markets : the case of U.S. and Australia. In: 16th Pacific Rim Real Estate Society
Conference, 24-27 January 2010, InterContinental Hotel, Wellington, New
Zealand.

© Copyright 2010 Bwembya Chikolwa

Dislodgement of Commercial Property Public Debt Markets:
The Case of U.S. and Australia
Bwembya Chikolwaa♣
School of Urban Development, Queensland University of Technology,
Brisbane QLD 4001, Australia♣

Tel.: +61 7 3138 4072; Fax: +61 7 3864 1170;

Email address: bwembya.chikolwa@qut.edu.au

1Dislodgement of Commercial Property Public Debt Markets:
The Case of U.S. and Australia
ABSTRACTThe paper investigates if there are any discernible trends in the U.S. and Australiancommercial property public debt markets with the onset of the global financial crisis(GFC). Commercial mortgage-backed securities and unsecured bonds issued by realestate investment trusts for the period 2000 to Q3:2009 are reviewed. It is shown thatevents in the equity markets have an impact on the pricing of these two instruments.
Furthermore, the impact of subdued activity in these financing instruments on thecommercial property market is discussed.
Keywords: REITs, A-REITs; Commercial mortgage-backed securities; unsecured bonds;
Global financial crisis

Introduction
Commercial mortgage-backed securities (CMBS) and unsecured bonds issued by realestate investment trusts (REITs) are vehicles which connect the public global fixedincome market with the real estate capital markets. Bonds provide an importantmechanism by which firms obtain new funds to finance new and continuing activities andprojects. Bond issuance has been recognised by REITs as an important debt funding tool.
A range of sophisticated debt products, including CMBSs, property trust bonds, hybrids
and off-balance sheet financing have been used by A-REITs (Chikolwa 2008a). The
stature of CMBS, with a range of subordination, is further reinforced as being essential
for broadening the investor base in real estate debt markets and reducing the commercial
property sector’s dependence on bank financing (Reserve Bank of Australia 2006).
The global commercial real estate market was estimated at US$12 trillion at the end of
2008, of which 58% was the commercial real estate debt market (RREEF Research
2009a). DTZ (2009) estimated that debt accounted for 70% of the U.S. commercial realestate market and that 20% of it was CMBS. An earlier study by Higgins (2007) had put
the Australian commercial property market at nearly AU$305 billion and delineated its
composition as equity 67% and debt 33%1. Chikolwa (2007) and Fitch Ratings (2007)
showed the Australian CMBS market to be around 7% of the total AU$70 billion
structured finance market at the end of 2006.
As such, the purpose of this paper is to investigate if there are any discernible trends in
the U.S. and Australian commercial property public debt markets with the onset of the
global financial crisis (GFC). Given the stature of commercial property markets and thesignificant role that debt plays in their operation and development, the GFC has resulted
in ceasing or contraction of commercial property public debt markets. Some of theevident results are fewer commercial property transactions, both within countries andacross borders; abandonment or postponement of development projects; increased
bankruptcies and delinquencies; and distress asset sales to pay down debt.

1

The current figure should be higher than this with increased commitments in the first half of 2007.

2

The study builds on earlier studies done by Chikolwa (2009) on the development andstructuring of CMBSs and unsecured bonds issued by A-REITs. The current study differsfrom previous studies as it considers market developments after 2007, in particular the
GFC and its impact on the two commercial property public debt funding instruments.
The paper is structured as follows. Section 2 reviews literature on corporate and CMBS
spreads. Section 3 discusses the data and methodology. The study results and discussion
are shown in Section 4. Property market implications are shown in section 5. Conclusions
are shown in Section 6.

Credit Spread Literature
Understanding corporate bond spreads is important because the spreads reflect market
participants’ aggregate perceptions about the relative financial health of corporate
issuers. Other things being equal, wider corporate spreads increase the cost of capital,
which may lead firms to postpone or scale back investment projects, whereby reducing
aggregate demand and muting inflationary pressure in the short run (Webber 2007).
Corporate borrowers pay higher yields on the bonds they issue than government pay on
bonds of the same maturity. Elton et al.(2001) explain the spread between spot rates on
U.S. corporate and government bonds in terms of three elements: (1) compensation for
expected default of corporate bonds, (2) compensation for state taxes since holders ofcorporate bonds pay state taxes while holders of government bonds do not, and (3)compensation for the additional systematic risk in corporate bond returns relative togovernment bond returns. Corporate default risk is driven by volatility, leverage, andinterest rates.
A number of recent studies (Collin-Dufresne, Goldstein & Martin 2001; Huang & Huang
2003) indicate that neither levels nor changes in the yield spread of corporate bonds over
Treasury bonds can be fully explained by credit risk determinants, with illiquidity
considered as adding to the variation (Longstaff, Mithal & Neis 2005; Van Landschoot2008) . Corporate bond holders require additional compensation for bearing the risk thatthey might not always be able to sell their claim immediately without incurring asubstantial price discount. Chen et al. (2007) state that liquidity alone can explain asmuch as 7% of the cross-sectional variation in bond yields for investment grade bondsand 22% for speculative grade bonds.
Van Landschoot (2008) show that U.S. dollar yield spreads are significantly more
affected by changes in the level and the slope of the default-free term structure and thestock market return and volatility. This finding, which holds for both financial-sector andindustrial-sector bonds, indicates that the S&P500 is seen as an important and meaningfulindicator for the U.S. bond market. Campbell and Taksler (2003) assert that equity
volatility explain movements in corporate yield spreads and their longer-term upward
movement. In their study, 22% of the actual change in spread is due to equity volatility.
This result supports an earlier study by Kwan (1996) that changes in the firm’s stock
price are negatively correlated with contemporaneous and future changes in the yields of
its bonds. Figure 1 shows an inverse relationship between NAREIT Equity total
returns/S&P 500 total returns index and 10-year U.S. treasury yields. It further shows
how NAREIT equities underperformed the S&P 500 index for much of 2007.

3

Figure 1:

NAREIT Equity Total Returns, S&P 500 Total Returns, and 10-Year
U.S. Treasury Yields

40

6

30
5
20
4

%

10

0

3

-10
2
-20
1
-30

-40
2000

0
2001

2002

2003

2004

2005

FTSE NAREIT Equity REITs Total Returns (lhs)

2006

2007

2008

Q3:2009

S&P 500 Total Returns (lhs)

10 Year U.S. Treasury Securities Market Yield (rhs)

Source: NAREIT
Batten et al. (2005) show that changes in credit spreads of Australian dollar denominatedEurobonds are negatively related to both changes in the return on All Ordinaries stockindex and changes in the Government bond yield. Figure 2.2 shows similar results to
those of the U.S. of real estate investment trust and stock exchange returns having an
inverse relationship to all series-all maturity bonds. It further shows how listed property
trusts (LPTs), now re-branded Australian Real Estate Investment Trusts (A-REITs),
under-performed the share market from the second half of 2007 and have just started
showing consistent signs of recovery.

4

Figure 2:

S&P/ASX A-REIT 300, ASX All Ordinaries and CBA Bond Returns

20.0

20.0

10.0
15.0

0.0
-10.0

10.0

%

%

-20.0
-30.0
5.0
-40.0
-50.0

0.0

-60.0
-70.0

-5.0

Mar-09Sep-08Mar-08

Sep-07Mar-07

ASX All Ordinaries (lhs)

Sep-06Mar-06

Sep-05Mar-05

Sep-04Mar-04

Sep-03Mar-03

Sep-02Mar-02

Sep-01Mar-01

S&P/ASX A-REIT 300 (lhs)

CBA Bond: All Series, All Maturities (rhs)

Source: PCA/IPD, ASX and CBA
Credit and liquidity risk premia increased abruptly during the recent financial market
turmoil. The fundamental uncertainty surrounding the value of some credit derivative
instruments appears to have been reflected in corporate bond spreads as higher
compensation for unexpected default losses. Alongside these increases, corporate bondilliquidity premia also appears to have risen – consistent with the recent drying up ofliquidity in money markets (Webber 2007). Collin-Dufresne et al (2001) present a
contrary view that the dominant component of monthly credit spread changes in thecorporate bond market is driven by local supply-demand shocks that are independent ofboth changes in credit-risk and typical measures of liquidity.
Corporate bond ratings inform the public of the likelihood of an investor receiving thepromised principal and interest payments associated with the bond issue (Shin and Han,
2001). The assigned ratings are important due to the implications they contain regarding
the bond issue. Lower credit ratings command higher spreads (Duffee 1998). Market
yields correspond to bond ratings, which indicate an association between rating and risk.
The higher the credit quality the lower will be yield and the more successful will be theissue (Alles 2000; Kose, Lynch & Puri 2003). Furthermore, any credit revisions will havean impact on the yield obtainable on corporate bonds. Hite and Warga (1997) reveal thata significant announcement effect to downgraded firms in both the announcement monthand pre-announcement period, with the magnitude of the downgrading effects increasing
drastically moving from investment-grade to non-investment grade firms. For instance,
this partially explains why the downgrade of Lehman Brothers’ bonds by Standard andPoor’s in September 2008 had a contagion effect on the entire bond market andexacerbated turmoil in the financial markets.

5In their study on the determinants of CMBS yield spreads, Titman et al. (2005) assert thatmortgages on property types that tend to be riskier and have greater investment flexibility
exhibit higher spreads. Spreads widen and mortgage terms become stricter after periodsof poor performance of the real estate markets and after periods of greater default rates ofoutstanding real estate loans. Xu (2007) further adds that the required returns on CMBS
are positively driven by the changes in credit spread, but this positive effect is muchstronger for high-yield CMBS than for investment-grade CMBS. She also adds thatchanges in the amount of CMBS issuance show a significant negative lag effect on
CMBS excess returns.

Methodology and Data
The study surveys commercial property public debt markets in the U.S. and Australia,
focussing on CMBSs and REIT unsecured bonds, to investigate any discernible trends
with the onset of the GFC. The following sources of data are utilised:
United States•
REIT stock: SNL database; NAREIT.
•
Treasury rates and corporate bond rates: Federal Reserve•
Investment returns: FTSE NAREIT US Real Estate Index Series; S&P 500
Index.
•
CMBS: Trepp; Commercial Real Estate Direct database; Commercial
Mortgage Securities Association database; Commercial Mortgage Alertmagazine; Realpoint database.
•
REITs unsecured bonds: NAREIT; Commercial Mortgage Alert magazine.
Australia•
A-REIT stock: AspectFin database; S&P Ratings Direct database; SNL
database.
•
Treasury rates and corporate bond rates: Reserve Bank of Australia•
Investment returns: PCA/IPD Property Index; S&P/ASX A-REIT 300; ASXAll Ordinaries; CBA Bond: All Series, All Maturities.
•
CMBS: S&P CMBS presale reports.
•
A-REITs unsecured bonds: PCA/CBA database.
Answers to the following questions are the focus of this study:• How has the GFC affected the development and performance of financing
prospects of REITs/A-REITs using CMBSs and unsecured bonds?
• Is there a relationship in the pricing of CMBSs and unsecured bonds and events inthe broader stock market?
• What are commercial property market implications of the ‘thawed’ CMBS and
unsecured bonds markets?
This interpretive historical approach (Baumgarter & Hensley 2005) provides a cogent
review and explanation of features of U.S. and Australian commercial property public
debt markets. This helps to understand the changing nature of these markets and provides
better understanding of the present and suggests possible future directions.

6Analysis and Discussion
U.S. CMBS Market 1990 – Q2:2009
The U.S. has been leading the way in global issuance of CMBSs. For the period 1990 to
Q2:2009, CMBSs totalling over AU$1,394.1 billion (US$1,233.7 trillion)2 had been
issued in the US. Figure 3 shows the total amount of CMBS issuance per year since
1990.
Figure 3:

US CMBS Issuance 1990 – Q2:2009$206.0

150

$77.8

$74.4
$52.1

$48.7

$0.6

1995

$12.1

$15.7

1994

$36.8

$17.4

1993

1991

$17.2

$7.6

1990

1992

$3.4

$14.0

$26.4

50

$56.6

$74.3

100

$93.1

US$ Billions$169.2200$230.2250

0Q2:2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

Source: Commercial Mortgage Alert (2009)
Although the U.S. CMBS issuance rose from AU$3.8 billion (US$3.4 billion) in 1990 to
AU$260 billion (US$230 billion) in 2007, the market drastically fell to AU$13.7 billion(US$12.1 billion) in 2008 and AU$722.3 million (US$639 million) in 2009, respectively,
due to turmoil in the financial markets alluded to earlier.
Table 1 shows over US$1,769 billion worth of CMBSs are set to mature between 2009
and 2018. With the current GFC, refinancing maturing CMBSs is a major concern as
most credit markets are currently either shut or operating at dramatically reduced levels.
Deutsche Bank (2009) note that at least two thirds of the loans maturing between 2009
and 2018 (US$410 billion) are unlikely to qualify for refinancing at maturity without
significant equity infusions from borrowers and that for the 2007 vintage, well in excessof 80% of the loans are unlikely to qualify.

2

For ease of comparison, the interbank exchange rate of US$1=AU$ as at 30 September 2009 has
been used.

7

Table 1:

Annual Maturities in U.S. CMBS, Banks and Life Companies

Year

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018 2009-2018

CMBS -Fixed Rate

17.6

32.2

44.1

57.6

40.9

54.2

104.5

133.9

148.2

6.1

639.3

32%

CMBS - Floating Rate

1.5

6.2

17.8

17.7

0.7

20.6

25.7

27.3

21.4

16.3

155.2

8%

Insurance Company

16.8

19.8

23.1

26.1

24.8

110.6

6%

Bank/Thrift

168.1

188.3

210.9

236.2

264.6

1,068.1

54%

Total (US$ billion)

204.0

246.5

295.9

337.6

331.0

1,973.2

100%

74.8

130.2

161.2

169.6

22.4

% of Total

Source: Deutsche Bank (2009)

US CMBS Pricing
Historically, conduit transactions have had strong investor appeal as evidenced bycontraction in spreads until July 2007. Figure 4 shows the 10-year fixed conduit spreads
between January 2000 and September 2009. From 2001, spreads fell from a high of 53bp
to just less than 30bp as at the end of 2006 (Commercial Mortgage Alert 2007). They
remained stable around 30bp until the advent of turmoil in the financial markets from
July 2007, reaching an all time high of just under 1,109bp in March 2009, breaking theprevious record of 111bp following the Russian bond market default crisis in 1998.
Figure 4:

U.S. 10-Year Fixed Conduit Spreads and 10-Year Treasury Rates January
2000 – September 2009

7.00

1200

1000

6.00

800

600

Bp

%

5.00

4.00
400
3.00

200

0

2.00

Jul-09

Jan-09Jul-08Jan-08

Jul-07

Jan-07

Jul-06

Jan-06

Jul-05Jan-05Jul-04Jan-04

Jul-03Jan-03

Jul-02Jan-02

Jul-01

Jan-01

Jul-00

Jan-00

10 Year Treasury Rate (lhs)

10 Year Fixed Conduit Spread (rhs)

Source: Commercial Mortgage Alert (2009)
To further highlight the rapid deterioration of the market, spreads rose by 128% from justabove 30bp from January to December 2007 and 627% from June 2008 to March 2009,
respectively; see Figure 5.

8

Figure 5:

U.S. 10-Year Fixed Conduit Spreads and 10-Year Treasury Rates June2007 – September 2009

6.00

1200

1000
5.00

4.00

600

Bp

%

800

400
3.00
200

0

2.00

Sep-09Jul-09Aug-09

May-09Jun-09Mar-09Apr-09

Jan-09Feb-09Dec-08

Oct-08Nov-08

Sep-08

Jul-08Aug-08Jun-08May-08Mar-08Apr-08Jan-08

Feb-08Dec-07

Nov-07

Sep-07

Oct-07

Jul-07Aug-07

Jun-07

10 Year Treasury Rate (lhs)

10 Year Fixed Conduit Spread (rhs)

Source: Commercial Mortgage Alert (2009)
Spreads for both BBB rated and AAA rated CMBSs continued to rise in 2008 reaching
all time highs in November 2008 and March 2009, respectively. For instance, 5 year
AAA rated CMBSs reached a high of 1,500bp and 5 year BBB rated CMBSs reached5,000bp; see Figure 6. Spreads fell significantly with the inclusion of legacy and new
CMBS into the Term Asset-Backed Securities Lending Facility (TALF) program andhave been stable closing at just under 400bp for 3 year AAA-rated notes and just under
3000bp for 3 year BBB-rated notes as at September 2009.
Figure 6:

U.S. 3-5 Yr AAA CMBS Spreads (lhs) and US 3-5 Yr BBB CMBS Spreads(rhs)

Source: ESF and Trepp LLC

9

US CMBS Performance
Good measures of CMBS performance are credit rating upgrades and downgrades by thecredit rating agencies. Credit rating upgrades depict mainly an improvement in theperformance of the underlying asset backing a CMBS issue and downgrades the opposite.
As the U.S. housing crisis continued to deepen in 2007, Fitch’s global structured financerating actions took a decidedly negative turn, driven overwhelmingly by theunprecedented credit deterioration in the U.S. subprime mortgage sector. By year’s end,
U.S. subprime-related downgrades affected 3,529 tranches, or 77% of the year’s 4,570
global structured finance downgrades. Total downgrades readily topped upgrades of
1,790, the first year in recent history to see such a trend in structured finance. However,the nonmortgage ABS and CMBS sectors reported more upgrades than downgrades in2007 (Fitch Ratings 2008b).
According to Fitch Ratings (2009) by the end of 2007, the ratio of upgrades todowngrades was 10:1 (the highest ratio for structured finance products). Of the nearly
7,166 CMBS deals they rated, the surveillance group upgraded 776 tranches anddowngraded 70. In 2008, downgrades exceeded upgrades at 392 and 290, respectively, ofthe 7,003 CMBS deals rated.
Commercial property values declined sharply in 2008 and are expected to continue todeteriorate in 2009. Not surprisingly, delinquencies on CMBS loans are also on the rise,as the liquidity crunch makes refinancing difficult at best and macroeconomic pressurestake a toll on consumer and business spending and, ultimately, on property occupancy
rates and rents; see Table 2.
Table 2:

U.S. Conduit CMBS Delinquency 1998 – Q3:2009

Vintage

Number of Loans

Number ofTransactions

Outstanding
Balance(US$bn)Total Deliquency

1998

1,497

32

6.9

6.87%

1999

2,241

35

10.5

3.88%

2000

3,622

31

19.2

2.50%

2001

4,105

35

26.3

2.40%

2002

3,783

35

27.6

1.43%

2003

5,120

47

41.9

1.01%

2004

6,248

59

63.9

9.80%

2005

10,338

64

130.6

1.24%

2006

11,925

65

160.0

1.75%

2007

12,769

65

197.7

1.68%

2008

819

8

10.7

3.04%

11.81

4.31%

Q3:2009

1,039

Source: DBRS and Trepp LLC
10

U.S. REITs Bond Issuance
US REITs issued a total of US$125.5 billion unsecured debt and US$12.7 billion secured
debt, respectively, from 2000 to Q3:2009. Issuance of these two debt funding instruments
has been affected by the GFC, with issuance reducing from 2006 for unsecured debt andno secured debt issuance from 2007; see Table 3.
Table 3:
Year
2000
2001
2002
2003
2004
2005
2006
2007
2008
Q3:2009
Total

US REITs Debt Issuance 2000 – Q3:2009
Unsecured Debt
US$ million
No. of Issues$7,01370$9,895
44$10,63871$10,89468$17,306
97$16,330105$25,26182$18,155
43$5,173
11$4,86517$125,530
608

Secured Debt
US$ million
No. of Issues$529
2$2,7754$745
3$1,3586$0
0$5,75836$1,551
3
$0
0
$0
0
$0
0
$12,716
54

Source: SNL Financial, NAREIT®
Spreads increased in response to the turbulent financial markets. For instance, 10 year
BBB rated unsecured notes spreads increased from a monthly average of 130bp in
January 2007 to 667bp in September 2007.
Figure 7 shows an increase in spreads between U.S. seasoned corporate bond yields andtreasury securities from September 2007 to reach an all-time high in November 2008.
From then on, spreads started to narrow, though still higher than the pre-GFC averagelevels.

11

Figure 7:

Spread between U.S. Corporate Bond Yields and Treasury Securities
Yields January 2000 – September 2009

10
9
8
7
6

%

5
4
3
2
1
0
2000-01

2001-01

2002-01

2003-01

2004-01

2005-01

2006-01

2007-01

2008-01

2009-01

Moody's All Industries Aaa Seasioned Corporate Yield
Moody's All Industries Baa Seasioned Corporate Yield
2 Year U.S. Treasury Securities Market Yield
10 Year U.S. Treasury Securities Market Yield

Source:Federal Reserve

As discussed earlier, refinancing corporate debt securities including those of REITs, is amajor concern in the current financial market. US REITs have US$66.5 billion worth ofbonds maturing in 2009 - 2010, of which 41% are by Retail REITs; see Figure 8.
Figure 8:

Maturity Profile of US REIT Bonds 2009 – Post 201860

US$ Billion

50
40
30
20
10
0

>2018

2018

2017

2016

2015

Source:

2014

2013

2012

2011

2010

2009

All REITs

Retail REITs

SNL Financial, NAREIT®

Australian CMBS Market 2000 – Q3:2009
With the drop in public bond issuance, unsecured bonds and CMBS issued by A-REITs
were an attractive investment option for superannuation funds. Outstanding long-term
government securities in Australia were stable averaging around AU$115 billion fromJanuary 2000 to September 2007. With the onset of the GFC, federal government
12

announced economic stimulus packages to counter the GFC, of which bond issuance is
one of the main funding tools. As at July 2009, a total of AU$205 billion of long-term
government securities were outstanding. On the contrary, outstanding amounts for otherdebt securities; in particular asset-backed securities3, which had increased from AU$17.5
billion to reach an all time high of AU$126 billion in September 2007, declined to
AU$99 billion in July 2009. Figure 9 shows outstanding debt securities from January
200 to July 2009.
Outstanding Debt Securities January 2000 – July 2009

120

120

100

100

80

80

60

60

40

40

20

20

0

0

2009

140

2008

140

2007

160

2006

160

2005

180

2004

180

2003

200

2002

200

2001

220

2000

220

Financial Corporate Securities

Non- financial Corporate Securities

Asset-backed Securities

Non-resident Securities

AU$ Billions

AU$ Billions

Figure 9:Federal & State Govt Securities

Source: Reserve Bank of Australia (2009)
Over the period 2000 to 2009, a total of 73 CMBSs with over 190 tranches worth over
AU$16.7 billion had been issued, excluding credit lease and small ticket transactions.
The CMBS market remained closed from Q3:2007 until the Macquarie CountryWide Pty
Ltd. AU$265 million AAA-rated CMBS issue in late August 2009. The most dominant
CMBS issues from 2000 to date are in the office property-backed sector (AU$6 billion),
followed by the retail (AU$4.8 billion) and the diversified property-backed sectors(AU$4.5 billion), respectively. The industrial property-backed sector had AU$1.4 billion
worth of CMBS issuance (Figure 10).

3

These include commercial mortgage-backed securities.

13

Figure 10:

Australian CMBS Issuance by Sector 2000 - Q3:2009

4,500
4,000
3,500

AU$m

3,000
2,500
2,000
1,500
1,000
500
0
2000

2001

2002

2003

Diversified

2004

2005

2006

Industrial

OfficeRetail2007

2008

Q3:2009

Source: Author’s compilation from various S&P CMBS Credit Rating Reports
During the same period, retail property-backed issues had the most tranches at 34%,
followed by diversified property-backed issues at 29% and office property-backed issues
at 25%. The least number of tranches were in the industrial backed issues at 12%. This isshown in Table 4.
Table 4:
SectorAustralian CMBS Issuance by Tranche Type and Amount 2000 – Q3:2009
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2000-2009

Diversified

0

2

11

7

7

14

14

2

0

0

57

29%

Industrial

0

3

6

12

0

3

0

0

0

0

24

12%

Office13Retail4

T otal58% of Total

4

5

4

10

11

12

0

0

50

25%

15

9

9

8

18

2

0

2

67

34%

36

33

20

35

43

14

0

2

198

100%

Source: Author’s compilation from various S&P CMBS Credit Rating Reports

Australian CMBS Pricing
Given the general appetite for fixed-income securities and the limited supply in themarket, CMBS credit spreads were contracting until the end of 2005 and stabilised fromthe start of 2006 until July 2007 as shown in Figure 11. In 2005, 5-year AAA, interest
only notes were priced at 20bps - 25bps over three month bank bill swap rate (BBSW),
and three-year, interest-only notes at 17bps - 20bps over three-month BBSW. BBB rated
notes were priced at 60bps - 95bps over BBSW. At the beginning of 2006, both 3-year
and 5-year AAA-rated notes were trading at average ranges of 8bps - 10bps; as at the endof 2006 they were trading at average ranges of 15bps - 17bps, a trend which continued
until July 2007. From then on AAA-rated note spreads increased by 170% to close at 40
bp in January 2008. No spreads were recorded from then on until the Macquarie
14

CountryWide Pty Ltd. CMBS in September 2009 which was priced at 410bps. This
reflects the worsened debt market conditions as a result of the US sub-prime mortgage
market events. The resultant credit crunch in the global financial system due to anincreased perception of risk on the part of lenders meant that they demanded greater
compensation hence increased credit spreads.
Average Spreads on Australian CMBS April 2003 – September 2007

50

50

45

45

40

40

35

35

30

30

25

25

20

20

15

15

10

10

5

5

0

0
Sep-07

Apr-07

Nov-06

Jul-06Mar-06

Sep-05

May-05Jan-05Aug-04

Apr-04

Dec-03Aug-03

Apr-03

3 year average BBSW

Average BBSW (bps)

Average BBSW (bps)

Figure 11:

5 year average BBSW

Source: Author’s compilation from PCA (2009)
The implication of high credit spreads was that it became uneconomical to issue CMBS.
For instance as at September 2007, issuance of AU$300 million AAA-rated 5 year
CMBS notes with a margin of 35bps over 3 month BBSW and 1% issuance cost, would
have not resulted in any saving, using the RBA business weighted-average interest rate of
7.50% as a pricing benchmark. However, CMBS issuance at 20bps could have resulted ina saving of AU$450,000 or 0.15% p.a. This is illustrated in Table 5.
Table 5:Australian CMBS Hypothetical Pricing Sept 2007
Spread of 35bps
6.95%
0.35%
0.20%
7.50%
7.50%
0.00%
AU$0

NAB 3 month BBSW (Sept 2007)
Add expected margin for AAA-rated CMBS
Add expected issue costs, assumed at 1%, over 5 years
Total expected cost of CMBS
RBA business weighted-average interest rate (Sept 2007)
Expected loss/profit
Expected loss/profit on AU$300m CMBS p.a.

Spread of 20bps
6.95%
0.20%
0.20%
7.35%
7.50%
0.15%
(+)AU$450,000

Source: Author’s adaption from Debelle (2008)
Furthermore, though CMBS issuance was theoretically possible at a spread 35bps, thedrawbacks of complexity and lengthy structuring duration over bank debt (Jones Lang15

LaSalle 2001) outweighed the benefits. This view is firmed by the fact that A-REITs had
an equal debt funding preference of bank debt and CMBS before Q3:2007 (Chikolwa
2008b) and that all CMBS that matured in 2007 and 2008 were refinanced using bankdebt (Fitch Ratings 2008a). This is self-evident in the Macquarie CountryWide Pty Ltd.
CMBS issue priced at 410bps, which anecdotal evidence shows is comparable to directbank lending margins of base rate plus 450bp – 500bps.
In a study on the structuring issues for CMBS in Australia, Chikolwa (2008b) showedthat originators/issuers and arrangers of Australian CMBs were of the view that ideal
pricing for AAA-rated notes should start at below 20bps and over 50bps for BBB-rated
notes. The study presented survey results of factors considered by issuers and arrangers
of Australian CMBS to obtain high credit ratings and those considered in the pricing of
the issues to ensure their success. CMBS issuers and arrangers were surveyed in August
2007 and January 2008, respectively. The two survey groups further indicated that due
to the credit squeeze during the survey periods, pricing of AAA-notes could range
between 60bps – 80bps and BBB-notes between 200bps – 300bps. Table 6 shows
responses of CMBS issuers, whose identities are not reviewed due to confidentiality
issues.
Table 6:
Individual CMBS Issuer Responses – Pricing CMBS August 2007
CMBS Issuer
Respondent 1
Respondent 2
Respondent 3
Respondent 4
Respondent 5

AAA-Rated Notes (bp)
3 Years
4 Years
5 Years
21 - 25
21 - 25
10 - 20
21 - 25
21 - 25
21 - 25
10 - 20
10 - 20-

BBB-Rated Notes (bp)
3 Years
4 Years
5 Years
71 - 80
51 - 60
61 - 70
61 - 70
61 - 80
41 - 50-Australian CMBS PerformanceStandard and Poor’s (2007, 2008, 2009), as part of their half yearly CMBS performancewatch for December 2007, December 2008 and June 2009, respectively, show
deterioration in commercial property market conditions, though most CMBS programs
performed well despite the challenging environment. This is shown below:

16

CMBS credit
ratings:

Commercial
property market:

CMBS programs:

December 2007
• Stable over the six months withno actions taken.
• A large number of rating
affirmations in the second half of2007.
• Good fundamentals, with limited
supply, strong occupancy, andreasonable prospects for rental
growth.
• Capital value increases outpacing
the rate of rental growthcontinued in the December
period.
• High overall occupancy levels.
• Weighted average lease durations(WALDs) in excess of 5.9 years.
• Effective management of thelease profiles for each of the
programs.

December 2008
• Five CMBS transactions affirmed
and one downgraded. Other
downgrades occurred in credit
lease transactions.

June 2009• Four CMBS transactions affirmed
and two downgraded• Investor sentiment deteriorated
with institutional investors
inactive.
• AU$15-AU$20 billion commercial
property glut for sale.
• Yields softened to 100bps, withrental growth supporting value
growth.
• Vacancy rates were on theincrease, though overall portfolio
vacancy rates remained low.
• Mixed WALDs though higher than
4 years.
• 29% of outstanding CMBSs
maturing in 2009 to be refinanced
outside the securitisation space.

• Occupancy levels and rental
growth remained fairly stable.
• Capital values continued to soften
due to limited liquidity andincreasing capitalisation rates.

• Reduction in capital values of
CMBS programs due to downward
revaluation of or sale of someproperties.
• Decline in WALD due to pending
maturities.

Standard and Poor’s further stated that the CMBS market will continue to be constrained
for the rest of 2009.

A-REIT Bond Issuance
A-REIT bond issuance from 2000 to Q3:2009 reached a cumulative total volume of
AU$10.7 billion, with 90 issues as shown in Figure 12. Generally, issuance volumes
were on the increase except of the year 2004. With the advent of the GFC in 2007,
issuance drastically reduced to AU$490 million in 2007 and all together ceased for thewhole of 2008. The market opened again in May 2009 with the AU$125 million CFSRetail Property Trust Medium Term Note (MTN) Issue. This was followed by the
AU$160 million Dexus MTN Issue in July 2009. Prior to the thawing of the public debt
markets, a good number of A-REITs recapitalised by issuing seasoned equity offerings(SEOs). Between Q2:2008 and Q2:2009, SEOs worth AU$15.9 billion were issued by AREITs, of which 65% were in the first half of 2009.

17

AU$ Million

Figure 12:

Australian A-REIT Bond Issuance and Equity Raisings Ex. IPOs 2000 –Q3:2009$12,000

30$10,000

25$8,00020$6,00015$4,00010$2,000

5

$0

0
2000

2001

2002

2003

2004

2005

2006

2007

2008

Q3:2009

A-REIT Equity Raising Ex. IPOs (lhs)
A-REIT Bond Issuance (lhs)
No. of A-REIT Bond Issues (rhs)

Source: Author’s compilation from PCA (2009) and Connect 4 Company Prospectuses
database (1999-2006)
Furthermore, some A-REITs have issued unsecured bonds in the deeper U.S. andEuropean bond markets to exploit the longer bond tenures and much more favourable
interest rates in comparison to the Australian bond market. Examples are the June 2008
AU$520 (₤250 million) Goodman MTN Issue in Europe and issues in the U.S. by Dexus(US$300 million in September 2009) and Westfield (US$700 million in May 2009 andUS$2 billion in September 2009, respectively).
To further emphasise the importance of issuance of unsecured bonds by A-REITs as afunding source, they are compared with CMBS4 from 2000 to Q3:2009; see Table 7.
Although more funds have been raised via CMBS (AU$17.1 billion) than A-REIT bonds(AU$10.7 billion), more A-REIT bonds (total number issued 90) have been issued in
number than CMBSs (total number issued 73). Furthermore, in certain years (2001 and2003) more funds where raised via A-REIT bonds than CMBS issuance.

4

A-REITs and their unlisted wholesale funds have a 85% CMBS market share.

18

Table 7:

Australian A-REIT Bond Issuance and CMBS Issuance 2000 –Q3:2009

Year

Australian CMBS Issuance
AU$ million

A-REIT Bond Issuance

No. of Issues

AU$ million

No. of Issues

2000

$357

2

$100

1

2001

$1,3205$1,61512

2002$2,84519$1,57012

2003$2,19114$2,79228

2004$1,513

7

$905

9

2005

$2,1028$1,32012

2006$4,01311$1,65011

2007$2,500

6

$490

3

2008

$0

0

$0

0

Q3:2009

$265

1

$285

2

Total

$17,106

73$10,72790

Source:Author’s compilation from various S&P CMBS Presale Reports and PCA(2009)

Figure 13 shows an inverse relationship between industry spread to swaps and 10-year
government bond rates until August 2007 when they rose from 35bp to close at 75bp inDecember 2007. This upward trend reached crescendo at 1,067bp in May 2009 for two
GPT unsecured bond issue. Spreads are lowering; with an average of 350bp in August
2009.
Figure 13:

A-REIT Average Industry Bond Spread to 10-year Government Bonds
2003 – 2007

75

6.25

70
6.00
65
60

5.75

5.50
50
45

5.25

40
5.00
35

1-3 Yea r A-REIT Bond (lhs)

Source:Author’s compilation from PCA (2009)19

Oct-07

Dec-07

Jun-07Aug-07

Apr-07

Feb-07

Oct-06

Dec-06

Jun-06≥5 Yea r A-REIT Bond (lhs)Aug-06

Apr-06

Feb-06

Oct-05

Dec-05

Jun-05Aug-05

Apr-05

Feb-05

Oct-04

Dec-04

Jun-04Aug-04

Apr-04Feb-04

Oct-03

Dec-03Jun-03Aug-034.75
Apr-0330

10 Year Govt. Bond Ra te (rhs)%55

Like all debt securities, refinancing of matured A-REIT bonds has been a major concern
following turmoil in the financial markets. Figure 14 presents the maturity profile of all
the A-REIT bonds from 2009 onwards. Nearly AU$2.3 billion worth of A-REIT bonds
will mature in 2009 - 2010, of which 61% are BBB rated bonds. As investors require
greater compensation to invest in BBB rated bonds, refinancing will become more
expensive.
Figure 14:

Maturity Profile of Australian A-REIT Unsecured Bonds

1,400

1,200

AU$ million

1,000

800

600

400

200

0

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

BBB ra ted notes

A ra ted notes

Source: Author’s compilation from PCA (2009)

Implications for the U.S. and Australian Commercial Property Markets
There has been a marked reduction in the number of commercial property sales in the
U.S. and Australia. For instance, in Australia CB Richard Ellis reported a 60% fall insales to AU$3 billion in the first half of 2008 (Condon 2008). Unavailability of or
expensive debt funding has contributed to the conundrum. Constraints are not only
confined to local borders, but are also international. RREEF (2007) documented thegrowth in international real estate securities funds, whose goals are to maximise portfolio
returns and indeed to acquire quality assets not locally available in investors’ localities.
Real Capital Analytics (2009a) state that the number of commercial property transactions
reached a record high of US$1 trillion in 2007, but fell drastically to US$504 billion in2008. Australian investment into the U.S. real estate market has moved from 3%(AU$5.5 billion) in 2006, to 32% (US$162 billion) in 2007 and to 2% (US$2.8 billion) in2008 (DTZ 2007; RREEF Research 2009b), signifying the GFC adverse impact. The
market is beginning to rebound with US$233 billion worth of global real estatetransactions recorded for the first half of 2009 (Real Capital Analytics 2009a).
Another consequence of funding constraints to the commercial property market has been
the postponement and abandonment of development projects. For instance, in Australia
commercial office development activity is subdued with only twelve towers being built
in five state capitals. These average around 25,000m2 in size and are due for completion20

between 2009 and 2011. As for the U.S, there are classic examples of numerous
development projects put on hold or delayed due to lack of funding in cities such as Las
Vegas, e.g.: The Echelon, Fontainebleau, St. Regis, and in Chicago e.g.: the Trump
International Hotel and Tower. The fact that most traditional lenders to the commercial
property sector have explicitly stated their intentions to reduce their exposure to thesector has not helped matters, e.g. Westpac Banking Corporation and Suncorp Metway inAustralia. This does not auger well for A-REITs with stapled securities as property
development was seen a large contributor to value-growth.
Recognising the importance of the commercial property sector in having a vibranteconomy, the Australia government conceived the Australian Business Investment
Partnership scheme in January 2009 to provide liquidity to viable major commercial
property projects. Though this scheme has not come into effect due to opinion
differences in by legislators, it has shown government’s willingness to move in to
support the commercial property sector in times of dislodgement of debt funding
instruments. Similarly, in the U.S. the Term Asset-Backed Securities Loan Facility(TALF) now includes CMBSs. This scheme aims at promoting the flow of credit tobusinesses and households and to facilitate the financing of commercial property.
In the U.S., some major commercial property investors have filed for bankruptcy
protection or defaulted on their CMBSs or unsecured bonds partly due to refinancing
difficulties. As earlier discussed, U.S. CMBS delinquency rates are increasing. Similarly,
in Australia a number of REITs and property developers have been declared insolvent or
are under receivership after falling to re-structure or re-finance their debt, e.g. ABC
Learning, Babcock and Brown, Raptis, Record Realty.
To take advantage of the ‘funding gap’ and the possibility of distressed sales, a numberof global opportunistic funds have been set up. Their goal is to buy these assets cheaply
and offload them when the market recovers. Examples are Brookfield, Lone Star Real
Estate Fund II and Sam Zell. A total of 96 private equity funds worldwide raised
US$40.6 billion5, with 69% having a primary focus on North America, to take advantage
of unfolding commercial real estate investment opportunities (Preqin 2010). Other recent
developments have been three initial price offerings of mortgage REITs to buy distressed
CMBSs and other securities, e.g.: Invesco Mortgage Capital, Starwood Property Trust,and PennyMac Mortgage Investment Trust.
Finally, debate rages in investment circles on how US$542 billion of U.S. CMBS
maturating in 2010-2011 will be refinanced and the consequences of the inability torefinance. U.S. commercial real estate debt outstanding is US$3.4 trillion, of which 22%
is CMBS. A number of strategies have unfolded, with equity raisings and sale of assets topayment down debt being the most prominent. U.S. REITs issued US$29.8 billion worthof equity in 2008- Q3 2009, and their Australian counterparts, A-REITs, US$18.3 billion(AU$20.7 billion) over 2007:Q2 2009 (PIR 2009a, b). In 2009, Real Capital Analytics(2009b) report asset sales of US$10.1 billion and purchases of US$2.1 billion by U.S
public real estate companies over U.S$50 million. Australian companies had sales of
US$2.6 billion (AU$2.3 billion) and purchases of US$68.9 million (AU$60.9 billion). In
the U.S., policymakers are in support of orderly resolution of commercial real estate debt
5

At 2.5% market share, Australia has the largest investor base outside of North America and Europe.
Majority of these investors are superannuation schemes, e.g. Australia Post Superannuation Scheme(APSS).

21

default to avoid ‘fire-sales’. The October 30, 2009 Federal Reserve ‘Prudent Commercial
Real Estate Loan Workouts’ policy statement encourages loan modifications andextensions for creditworthy commercial real estate borrowers; in some cases, even if aproperty’s current value is below the loan amount (Federal Reserve 2009).

Conclusion
The paper builds on the earlier work done by Chikolwa (2009) on Australian CMBSs and
A-REIT unsecured bonds by investigating the impact of the global financial crisis on thetwo financial instruments in U.S. and Australia from 2000 to Q3:2009. It is shown thatevents in the share market have a bearing on the pricing of CMBSs and REIT unsecured
bonds.
Similarities are noted in the impact of inactivity in the funding instruments on the U.S.
and Australian commercial property market, albeit at different degrees. The constrainedcommercial property supply in Australia and stronger economic performance, has meantsome projects are still be undertaken despite funding problems and property values havenot fallen as much as in the U.S. Whereas the Australian commercial public debt markets
closed for 2 years from Q3:2007, the U.S. had some activity though at the low levels.
The CMBS and REIT unsecured market are now beginning to thaw in line with thegeneral view that the worst of the global financial crisis is over. Better access to readily
available cheaper public debt will result in increased commercial transactions.

22

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