The Father Of CMBS Says We’re In ‘Uncharted Territory’ When It Comes To Valuing Real Estate

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:18)

So Joe, one of the themes that I think has been popping up quite a bit on recent episodes is this idea of, this sounds really trite, but opportunity in crisis, or this idea that we're facing big, big economic devastation, but maybe there's some sort of hidden opportunity, or even very obvious opportunity, to remake the economic system or improve the financial system at the same time.

Joe Weisenthal (0:44)

Yeah, I think that's right. I mean, yeah, I think that has been a theme, and this idea that there are a lot of policies, and we've sort of talked a lot about fiscal policies or monetary policy, but there's all kinds of trends that have been going in one direction, and people are questioning, have they reached their endpoint as a society, as an economy?

Do we need to make some sort of like meaningful turn in a different direction?

Tracy Alloway (1:10)

Right, and times of crises tend to be when we also see new innovations in the market specifically, and I'm thinking about one in particular back in the 1990s, immediately after the savings and loan crisis, there was a shortage of capital going into commercial real estate.

Fast forward a few years, and someone invented commercial mortgage-backed securities to kind of take care of that problem. Now today, we've been discussing already the intense pain facing the commercial real estate sector at the moment. The question is, is this going to lead to some sort of innovation, or is it going to present some sort of opportunity to revisit the system as a whole? There are different types and different degrees of changes that could come about because of what we're seeing happen right now.

Joe Weisenthal (2:01)

Wait, you want to hear an interesting commercial real estate data point?

Tracy Alloway (2:07)

Go on. You're back in New York, aren't you?

Joe Weisenthal (2:08)

I'm in the office. I'm not only back in New York.

Tracy Alloway (2:12)

You're going to be brimming with commercial real estate anecdotes now, aren't you?

Joe Weisenthal (2:17)

So I'm literally in commercial real estate as we speak after several months of recording the podcast from a bedroom. So maybe it was all over hype. Maybe everything is going back to normal. But no, I don't know. It's definitely not normal by any stretch here in New York. It's definitely not normal by any stretch here in the office.

And it's really unclear whether there will be a return to normal at all.

Tracy Alloway (2:44)

Okay. Well, on this episode, we're going to be digging more into the state of the commercial real estate industry. We touched upon it a little bit when we were talking about REITs the other day, but now we're going to go in depth with a really, really special guest. I'm thrilled to say that on today's episode, we have Ethan Penner, who is widely credited as being the father of CMBS, or the guy that created it, as I mentioned back in the 1990s. He's currently the founder and managing partner of Mosaic Real Estate Partners. So, Ethan, thank you so much for coming on.

So, Ethan, I'm really curious. Could you maybe start out by describing the problems as you saw it in commercial real estate in the early 1990s, when you were first thinking about the CMBS structure, the CMBS product? What was the issue that you were trying to solve? And how much of that do you see paralleled in the current situation today?

Ethan Penner (3:48)

Well, it's not really paralleled at all at this point. I'd say the situation that existed in the early 90s that moved me to kind of bring about the CMBS industry or CMBS solution was a very unique situation where kind of all the lenders who had serviced the real estate industry abandoned the industry all at once.

And so the industry, which is, you probably know this, but real estate is the most dependent upon debt financing of all industries. And so here you had an industry that had its line cut off, essentially. And it's an industry that is financed not only acquisitions, of course, with heavy debt, but the debt itself is structured so that there was very little amortization and loans mature on a regular basis and need to be refinanced. And so borrowers were finding themselves in the early 90s with loans scheduled to mature and their existing lenders telling them, regardless of how well the loans were performing or the underlying properties, that they didn't have an interest in refinancing those loans and they might give some short extension, but the borrower needed to find a way to repay them. And so the industry was facing a tremendous crisis, an existential crisis for many borrowers. And I saw that and realized that the securities markets, the bond buyer who had come to finance other asset types, primarily single family mortgages, but other assets through the securization process that had kind of grown significantly through the 80s and that I had been a part of, was a very well-suited place to turn to, to fill this massive need.