Consider the truism that the "new CMBS," so-called 2.0, is safer because these issues were underwritten to prudent, post-crash standards. But, increasingly, in-place or realized income- based underwriting is going by the boards and more pro-forma based underwriting is making a comeback, enough so that earlier this year Barclays felt compelled to issue a warning about this return to lax standards.

Thus, for all the upheaval in the securities market over the past two years, some truisms remain. Namely, while there is opportunity for investing in cheaper debt, it will not be akin to picking blueberries in August. To guide distress investors through the latest tweaks and changes in the CMBS market, consider the following.

1. It's Not Over. It may seem that the window of opportunity has closed for distressed investment in securitized loans. Not so by a long shot, according to recent statistics from Trepp, which estimates that over the next three years, $1.2 trillion to $1.5 trillion of real estate debt will come due and need to be refinanced. Specifically, there is a pipeline of commercial mortgage-backed securities that will need refinancing, of which $60 billion can be classified as distressed. The majority of the debt is held by banks and then by insurers, according to Trepp. Banks, in particular, will make a good target for bargain-seeking investors, says Jeffrey Rogers, president and COO of Integra Realty Resources in New York City. "Banks are a lot healthier now," he says, "and they have built up REO departments. So we'll start to see those opportunities develop even more."
2. New Investors Will Join the Fray. One potential area for investment will come from GSE reform. Richard Adler, managing director with European Investors, told NAREIT in an interview held during the association's REITWeek in June that mortgage REITs are poised to grab the $4 trillion worth of existing residential and commercial mortgages that could be coming to market, as well as an estimated $1 trillion in CMBS that will need to be refinanced.
3. That Buy-Sell Gap? Still There. A stubborn gap between sellers and buyers' price expectations has been an issue since the start of the financial crisis, and it extended to securities. This has not gone away, says Matt Zifrony, a real estate attorney with the law firm Tripp Scott in Fort Lauderdale, FL. "We still find lenders that are unwilling to sell at a significant, or even modest, discount," he says. "They may be hopeful of a rebound in the economy. And we still see investors looking for pennies on the dollar." A new twist has emerged in pricing, though, he says. With extend and pretend winding down, distressed investors are taking into account the distinct possibility that they will have to usher a security through a workout or special servicing, which will add to the costs and extend the investor's wait for a payback. "All of that is being factored into what an investor is willing to pay," Zifrony says. "It can be difficult to get banks to focus on diverting assets when they know the buyer is going to insist on paying pennies on the dollar."
4. It's Who You Know. Indeed, one would think, given the structure of the capital markets, snapping up a distressed or stressed security is merely a matter of contacting the holder and going through the buy process. Not necessarily, Zifrony elaborates. A lack of trust among parties has made the process much harder, and oft en a transaction stalls for that reason, he says. "I can't tell you how many times I have gotten a call from someone with $100 million in liquid assets that he wants to unload," he says. "Investors meet with the individual or group and find out he didn't have what was originally represented."
5. Better Due Diligence Cycles. One piece of the investment process that is improving for investors is the time frame for due diligence, Rogers observes: "Due diligence is key. People have gotten burned when they were pressured to value securities in a matter of hours. You have to put the time in to make sure the underlying assets are appropriately valued, and the rhythm of the market is such that that's starting to be accommodated."
6. Think Sub-Investment Grade. The good news for distressed investors is that, while the investment-grade securities market is strong, Jonathan C. Black, a Boston-based partner in DLA Piper's Corporate and Finance group, says sub-investment grade has its weak spots, presenting investment opportunities. "Those portions of the stack haven't achieved full liquidity yet, which opens opportunities for hedge funds and other investors with a high tolerance for risk," he says.
7. Watch for an Open Field. There are also new areas of investment that may divert some distressed asset investors, leaving the field more open to the die-hard acquirer. New technologies and a resurgent economy are opening new opportunities that some investors, tired of waiting for distress, are likely to pursue. Investors are starting to look at financing equipment leases or aircraft assets, Black says. Another underutilized opportunity, he says, is whole business securitization for middle-market companies. "In the past, firms like these might have used leveraged loans in CDO structures," he says, "but now they can get a similar result via whole business securitization." Technology is also a driver of new business models that will draw investors out of the distressed space, Black adds. Most literally is the example of American Tower's recent conversion to REIT status. The provider of cell phone towers found it more profitable to go public. Data center REITs are also examples, Black says. "New opportunities are being created," he says. "Those opportunities need to be financed; they need credit facilities."

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