When it comes to structured commercial real estate (CRE) credit, the European market is at a pivotal juncture, explains Iain Balkwill, partner at Reed Smith.

Last year proved to be a ground-breaking year for the asset class; we saw a record volume of CMBS issuance and in an industry first, Starz Real Estate brought Europe’s first ever CRE CLO to the market. In stark contrast 2022 has been the antithesis of this, with less than a handful of CMBS issuances and the Starz CRE CLO continues to be the one and only transaction to grace European shores.

To add salt to the wound, as we enter the final stretch of the year, there is little sign of a shift to the status quo, a fact exacerbated by a deterioration in market fundamentals, chief of which is that capital market volatility has made it extremely challenging to price primary deals. Securitisation has once again demonstrated that (unsurprisingly) it is not immune to the ebbs and flows that plague the capital markets. Indeed, although parallels in some quarters are being drawn against the global financial crisis, in reality this is a very different crisis against a very different CRE lending landscape.

In time, the markets will stabilise and when they do securitisation will demonstrate that it has an integral role to play for financing CRE for the greater benefit of the economy as a whole. The reality is that today’s securitisation product is much improved and more than capable of weathering an economic storm, thanks to the strides made in not only embracing new regulation but also taking on board lessons of the past and adherence to investor guidelines and best practice principles.

The underlying collateral is also of a very different calibre, thanks to the implementation of more robust underwriting standards and the deployment of new and improved loan structures. The importance of this technology cannot be underestimated as all economies (other than Turkey….) embark on an escalator of rising interest rates forcing borrowers and alternate lenders alike to embrace more racier forms of finance to remain competitive and boost returns.

Given its myriad of positive characteristics, now is the time for CMBS and CRE CLOs to assume an integral role as a financing tool for CRE. After all, on a macroeconomic level, these structures are a great way of spreading and diversifying CRE risk whilst at the same time promoting much needed openness and transparency to the CRE lending market.

From an investor's perspective, the resultant product not only enables investment in a (relatively) liquid instrument that satisfies their risk/reward appetite, but is also an investment that offers a return that is pegged to fluctuations in interest rates. From a borrower’s perspective, debt that is ultimately financed through a securitisation will enable them to obtain a cheaper form of credit than compared to traditional sources of finance.

It is inevitable that the role of securitisation will receive a major boost as market participants grapple with the emergence of a macroeconomic environment of sustained and increasing interest rates. In terms of the specific CRE products themselves, then CMBS will continue to have a role to play as an arbitrage tool for those banks operating an originate-to-distribute model - although given that few banks have such a platform, then levels of issuance will remain muted. The real hero of the hour though is likely to be the newcomer, the CRE CLO.

In recent years, this product has enjoyed an immense level of unprecedented success in the US, thanks to its positive attributes and the fact that it is ideal for financing transitional CRE. Either way, the one inescapable fact is that both forms of structured product have an important role to play for financing CRE and accordingly now is the time for this technology to be embraced at scale.