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Commercial mortgage bond sales on a record pace

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NEW YORK -- The sale of debt backed by commercial real estate is on a record pace, bolstered by falling interest rates and rising property prices, according to Moody's Investors Service.

Issuance of commercial mortgage-backed securities, which consist of loans on everything from hotels to office buildings, rose 65 percent to $72 billion in the first half of the year from the same period of 2004, the credit ratings company said in a report Monday. The full-year record for issuance was $93 billion, set in 2004.

"People are taking advantage of historically low interest rates," Tad Philipp, managing director of the structured finance group at Moody's, said in an interview. "They also benefit from property values, which have been rising, and there are more people buying real estate."

Commercial real estate returned 9.53 percent in 2004, including price appreciation and investment income, according to a National Council of Real Estate Investment Fiduciaries index. The performance compares with a return of 2.98 percent for the Standard & Poor's 500 Index and about 3.5 percent for U.S. Treasury securities.

This year, the yield on the 10-year Treasury note, a benchmark for borrowing rates, has averaged 4.21 percent, below the average of 4.77 percent the previous five years. Commercial mortgage securities with top AAA ratings and with an average maturity of five years yields about 68 basis points more than Treasuries, compared with the peak of the past year of 80 basis points, according to Banc of America Securities.

The commercial mortgage-backed debt market has grown to about $900 billion since its inception in the early 1990s, said Philipp. This type of debt finances about two-thirds of all real estate transactions in the United States, he said. The size of the U.S. Treasury market is about $4 trillion.

Rising property prices may be making real estate investors "complacent," leading them to boost the size of loans relative to the value of the underlying properties, and increasing the risk of defaults, Philipp said.

Moody's measure of the size of commercial real estate loans relative to the value of the underlying properties was 100.5 percent in the second quarter, up from 95.2 percent in the first quarter, the credit rating company said in its quarterly report on the commercial mortgage-backed debt market.

This was the first time the average loan leverage surpassed 100 percent, Philipp and the study's co-author, Pamela Dent, wrote in their report.

At the same time, loans where borrowers only need to make interest payments rose to over 65 percent of new loans in the second quarter, compared with 56 percent during the first quarter, according to the report.

"People are getting complacent," said Philipp. "They seem to have forgotten the last crisis back almost 10 years ago," he said, referring to the loan crisis in the early 1990s when excessive growth of commercial property assets led to a glut and the savings and loan bailout.

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