Definition of Commercial Mortgage-Backed Securities
Commercial mortgage-backed securities, CMBS, are one form of asset-backed debt investment. These investments have similarities and differences from residential mortgage-backed securities. The CMBS market is not large or standardized. Many CMBS investments were originated in the real estate boom years of 2004 to 2007 and require additional investor scrutiny since the 2007-09 economic recession.
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Function
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Commercial mortgage-backed securities are asset-backed debt that derive their interest and principal payments from leases on commercial property. An individual CMBS may be for a group of commercial properties or a single property. They are used as an alternative funding source for commercial real estate investors. Commercial mortgage-backed security buyers receive a set rate of interest that is derived from the rents earned on the commercial properties. The securities can have a fixed maturity date or an amortization schedule.
Types
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Commercial mortgage-backed securities are sold on several types of commercial property. A single CMBS issue will hold loans on a specific type of commercial property. CMBS types are hotel properties, multi-family housing, office buildings, retail and industrial properties. According to the Wall Street Journal, the size of the CMBS market is approximately $500 billion.
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Potential
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Commercial mortgage-backed securities are attractive to investors for several reasons. CMBS are available with high credit ratings and attractive yields compared with comparable income investments. Many commercial mortgage securities are written with early prepayment penalties, so investors know they will earn the promised interest rate for a set period of time. This is in contrast to residential mortgage securities, where prepayment is a negative consequence in a falling interest rate environment.
Considerations
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There is no standardized format for commercial mortgage-backed securities. Each issue must be evaluated on its own merits. The Credit Union National Association has recommended its members look for CMBS with credit ratings of AA- or higher and where the mortgage pool includes at least 50 properties. The CMBS.com website warns that the rating agencies and investors may not have enough information about the properties to accurately access the risk.
Warning
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Many commercial mortgage security pools were originated when commercial properties were increasing in value and there was not a problem with tenants breaking their leases. The economic recession put many CMBS in default positions. National Real Estate Investor reported that hotel CMBS had reached a historic high default rate of 18 percent in April 2010. Investors should understand there may be significant risk involved in CMBS investing.
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References
- Photo Credit hotel image by jcpjr from Fotolia.com
