Talmage Notes from the Field – Boiling Frogs, Credit Bubbles and Commercial Real Estate

“The CMBS market appears to be at risk of developing a case of ‘boiling frog syndrome’.”
-Moody’s CMBS Quarterly Review, April 2014

“A high degree of monetary accommodation remains warranted.”
-Janet Yellen, Federal Reserve Chairwoman, Congressional Testimony, May 2014


Business Wire


According to the experts at various conferences and forums across the country, we are in the midst of a “credit bubble.” In their first quarter report for 2014, Moody’s reports that we are developing, “a case of ‘boiling frog syndrome,’ a situation in which participants fail to react to gradual changes until unfortunate consequences occur.” At the Milken Conference in April, Marc Rowan from Apollo tells us that, “All the danger signs are there for a future crisis. We’re back to doing exactly the same things that were done in the credit markets during the crisis.” Consider the following:

  • Moody’s CMBS 2.0 LTV ratio increases to 107% - within range of the pre-crisis peak of 118% in 2007;
  • $7+ billion of CMBS priced this month with robust subscription levels across the capital structure;
  • $12+ billion of CLOs issued in April 2014, the second largest monthly issuance in CLO history;
  • An 18-acre oceanfront estate in East Hampton, NY sells for $147 million, a new US property record;
  • “Three Studies of Lucien Freud,” by Frances Bacon sells for $142 million at Christie’s, a new record;
  • Alibaba files for its U.S. IPO seeking to raise as much as $20 billion with a $168 billion valuation; and
  • The Fed states that its key interest rate is likely to remain close to zero for a “considerable time” post tapering.

Despite these new benchmarks, commercial real estate fundamentals continue their gradual improvement, CMBS delinquencies continue to decline and property prices continue to increase – all of which make CMBS loans more secure. On the capital side, sophisticated investors are taking advantage of these trends. Goldman Sachs announced this week that it raised $2.4 billion (including $600 million of the firm’s own equity) for its second real estate credit fund and Oaktree Capital Management announced that their most recent real estate debt strategy fund had raised $800 million and is expected to close at over $1 billion in a sector that the firm thinks will, “continue to grow.”

Good values exist today in commercial real estate debt, they are just more difficult to uncover and require more discipline to find. Credit spreads remain stubbornly wide in CMBS as compared to pre-crisis levels and as compared to high yield and corporate bonds. Further, CMBS collateral quality and structures remain solid supported by strengthening underlying property fundamentals – even if leverage levels are on the rise.

Our approach given the current investment climate is four-fold:

1. Be tactical in size, be nimble and invest “under the radar” – harder to deploy capital today as a “mega fund”;

2. Buy on fundamentals (cash flow, sponsorship, asset quality, etc.) versus momentum;

3. Hedge risk by investing in floating-rate debt and in assets with shorter maturities; and

4. Invest in seasoned “legacy” transactions versus the freshly packaged “new issue” market at this point in the cycle.

Low interest rates, high asset prices and global instability create a challenging investment environment. Real estate debt remains highly attractive to us as a “sharp-shooter’s” business, particularly in the $400 billion legacy CMBS space that remains discounted to new issue due, in part, to its comparatively poor packaging, stale ratings and lack of readily available information. As Marc Rowan said, it is the manager’s job “to step wisely” and to avoid what got us into the credit crisis.

Keep disciplined and carry on.


Talmage, LLC (“Talmage”) is an independent investment manager with $1.5 billion of assets that specializes in commercial real estate credit. Talmage focuses on high-quality issuers and loans that are secured by institutional-quality real estate. Our investments emphasize asset quality, strong sponsorship, credit enhancement, liquidity, and current income. Our team has been investing together since 2003 and has made over $10 billion of investments in more than 500 transactions. Talmage is a rated CMBS Special Servicer with over $40 billion of transactional experience and is based in New York. www.talmagellc.com.

Talmage, LLC
Edward L. Shugrue III, +212-209-1380

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