Commercial Real Estate Gets a Fed Jolt

NEW YORK ( TheStreet) -- The Federal Reserve Bank of New York's sale of $7.5 billion of once-toxic commercial real estate debt last week is being applauded by investors as a slam dunk that may revive the moribund sector.

"It was very well received," said Edward L. Shugrue III, CEO of commercial real estate advisory firm Talmage. "It was a thoughtful and adroit move by the Fed and the timing was impeccable."

Last week the Fed said that it had sold an entire portion of American International Group's ( AIG) debt -- known as MAX CDO" -- to a group of bidders that included Barclays Capital ( BCS) and Deutsche Bank ( DB). The CDO (short for collateralized debt obligation) consisted of a large bundle of commercial mortgage-backed securities (CMBS) debt wrapped up into a single security that eventually went south on AIG.

The MAX CDO was purchased away from AIG during the height of the financial crisis, and the sale is part of a bigger government auction of AIG debt taken on by the Fed called the Maiden Lane III transactions.

Shugrue said the sale of MAX CDO -- and the subsequent flood into the commercial real estate market of its parts as Barclays and Deutsche Bank break it up -- proves that commercial real estate debt may be ready for a comeback as investors search for higher yielding products.

"Until this week the net supply of CMBS has been shrinking, but this sale proves that there is rich demand across the sector," Shugrue said. "The risk trade is on, and banks, money managers and hedge funds were eager to snap this up."

A report issued by Barclays last week echoed Shugrue's assertion that investors were ready to take on more commercial real estate debt. "For this week at least, it looks as if the CMBS market has been able to take down much of this new supply with little effect on prices."

The sale of the MAX CDO -- and the Maiden Lane III assets in general -- are not without critics. While AIG and its counterparties received 100 cents on the dollar for the assets in order to stave off bankruptcy of the giant insurer in 2008, the Fed is selling them off four years later at a discount. For example, Barclays and Deutsche Bank reportedly paid 70 cents on the dollar for the MAX CDO assets.

But in announcing the sale, the Fed argued that the MAX CDO selloff was part of a "competitive bidding process" that scored the best possible outcome for taxpayers.

"I am pleased with the level of interest and the results of this process, especially with the strength of the winning bid, which represents good value for the public and significantly exceeds the original price ML III paid for these assets," said William C. Dudley, president of the New York Fed. "This successful sale marks another important milestone in the wind-down of our crisis-era intervention."

Shugrue argued that taxpayers are served by having a successful sale and that any investment faces a risk of loss.

"CMBS is a $600 billion market," he said. "You need to be an informed investor. Caveat emptor."