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Commercial Mortgage-Backed Security (CMBS)



Definition

A Commercial Mortgage-Backed Security (CMBS) is a type of mortgage-backed security backed by commercial mortgages rather than residential ones. These commercial properties could include offices, malls, or hotels. The mortgages are grouped together and sold to investors who receive income from the commercial mortgage loans’ interest and principal repayments.

Phonetic

Commercial Mortgage-Backed Security (CMBS) is phonetically pronounced as “kuh-mur-shuhl mawr-gij bakd si-kyur-i-tee (see-em-bee-es)”.

Key Takeaways

  1. Structure: Commercial Mortgage-Backed Securities (CMBS) are structured as multiple tranches, each with different levels of risk and return. The tranches are typically ranked from senior to junior levels based on their credit risk.
  2. Investment Tool: CMBS are used as an investment tool, enabling individual and institutional investors to gain exposure to income-generating real estate properties. They provide a way to invest in real estate without having to directly own property.
  3. Risk and Return: The risk and return on a CMBS are determined by the quality of the underlying commercial mortgages. Investors can face the risk of default if borrowers fail to make their mortgage payments. However, in exchange for this risk, investors are offered higher potential returns compared to other fixed-income securities.

Importance

Commercial Mortgage-Backed Security (CMBS) is a vital instrument in the field of finance because it provides a unique avenue for raising capital. It refers to a type of mortgage-backed security backed by commercial property loans rather than residential real estate. Banks and loan originators can package these commercial loans together and sell them in the secondary market, which facilitates liquidity, risk distribution, and provides greater access to capital. This process allows lenders to free up more capital for additional lending, encourages growth in the commercial real estate market, and offers investors the opportunity to gain exposure to real estate without having to buy property outright. Therefore, the importance of CMBS lies in their role in enhancing market liquidity, fostering financial diversification, and enabling market participants access to finance.

Explanation

Commercial Mortgage-Backed Securities (CMBS) are an important instrument in the finance world, particularly for investors seeking a relatively low-risk investment with steady income and commercial real estate industry participants. The primary purpose of CMBS is to provide capital to commercial real estate investors, developers, and companies. These entities often need significant sums of money to engage in various projects, including constructing new buildings, renovating existing structures, or securing strong cash flows. Therefore, financial institutions bundle the loans and sell them as securities to investors, providing the needed funds for these endeavors.Moreover, CMBS plays a crucial role in risk diversification for the investors. Each security comprises numerous commercial mortgages from diverse sectors like retail, office, hotel, or multifamily residences. This variety lessens the likelihood that all properties will default on their loans simultaneously, ultimately reducing investor risk. Additionally, these securities are tiered into tranches based on risk, offering investors the flexibility to select tranches that align with their risk tolerance and investment objectives. On one hand, the higher-risk tranches provide greater yields, and on the other hand, the lower-risk tranches offer more security but less return.

Examples

1. In 2007, Blackstone Group acquired Hilton Hotels in a leveraged buyout. To finance its acquisition, Blackstone Group issued a CMBS, the BX Commercial Mortgage Trust 2007-HLH, through its subsidiary, Hilton Worldwide. This CMBS is one example of how companies can issue CMBSs to finance large-scale commercial real estate transactions or leveraged buyouts.2. In the 1990s, Lehman Brothers issued a CMBS backed by a portfolio of loans secured by various Sears properties. The loans included in the CMBS were diversified, representing properties in 41 different states across the United States. 3. Another prime example is the Goldman Sachs Mortgage Company which originated a $1 billion Commercial Mortgage-Backed Security deal in 2020. As the largest single loan included, the recently completed 1.2 million square foot SoNo Collection shopping centre in Norwalk offers a vivid illustration of the properties supporting such securitizations.

Frequently Asked Questions(FAQ)

What is a Commercial Mortgage-Backed Security (CMBS)?

A Commercial Mortgage-Backed Security (CMBS) is a type of mortgage-backed security that is secured by the mortgage on a commercial property. The mortgages are bundled together and sold as an investment product to investors.

How does a CMBS work?

Borrowers of commercial mortgages pay their mortgage payments to the lending bank. The bank packages a number of these mortgages together into a security which is then sold to investors. The investors subsequently receive income from the mortgage payments.

Why would someone invest in a CMBS?

An investor might invest in a CMBS for a couple of reasons. Firstly, the income from the mortgage payments provides a stream of income for the life of the security. Secondly, a CMBS is often considered a safe investment because it is backed by a tangible asset, the property.

What are the risks associated with a CMBS?

Risks associated with investing in a CMBS may include default risk (where borrowers don’t make their mortgage payments), interest rate risk (potential losses if interest rates increase), and liquidity risk (you may not be able to sell your investment when you want to).

Who invests in Commercial Mortgage-Backed Securities?

A variety of investors might buy CMBSs, including pension funds, insurance companies, money managers, and hedge funds. Commercial Mortgage-Backed Securities can provide a steady stream of income and diversification.

Are CMBSs and residential mortgage-backed securities (RMBSs) the same?

No, while they are similar, there is a difference. Residential Mortgage-Backed Securities (RMBSs) are backed by mortgages on residential properties, while Commercial Mortgage-Backed Securities (CMBSs) are secured by mortgages on commercial properties.

How does one sell or buy a CMBS?

CMBSs are frequently bought and sold on the secondary market, similar to stocks and bonds. The process usually involves a broker and the transaction typically occurs between institutional investors.

Related Finance Terms

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