What Is a Commercial Mortgage-Backed Security CMBS
What Is a Commercial Mortgage-Backed Security (CMBS)?
Commercial mortgage-backed securities (CMBS) are fixed-income investment products backed by mortgages on commercial properties. Unlike residential real estate, CMBS provide liquidity to real estate investors and commercial lenders.
Because CMBS structures are not standardized, their valuations can be challenging. They consist of various commercial mortgages with different terms, values, and property types, such as multi-family dwellings and commercial real estate. CMBS are less pre-payment risk than residential mortgage-backed securities (RMBS) because commercial mortgages typically have fixed terms.
Types of CMBS
CMBS mortgages are classified into tranches based on credit risk levels. Senior tranches have lower risk and pay lower interest rates. Mezzanine tranches offer higher yields but have more risk. Equity tranches provide the highest potential gains.
Components of a CMBS
A CMBS contract includes terms that determine its profitability. Factors to consider include interest rates, term length, and prepayment penalties.
Criticism of CMBS
CMBS is primarily invested in by wealthy individuals due to limited options for average investors. Mutual funds and exchange-traded funds (ETFs) don’t typically focus solely on CMBS, although some real estate mutual funds include them in their portfolios.
Requirements for CMBS
To reduce risks, the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) implemented regulations in December 2016, including margin requirements for covered agency transactions.
Advantages and Disadvantages of CMBS
CMBS loans offer fixed interest rates and are nonrecourse, making them attractive to borrowers. The loans can also be assumed by new owners when a property is sold. However, borrowers face penalties for early loan repayment.
Difference Between CMBS and RMBS
CMBS is backed by commercial real estate, while residential mortgage-backed securities (RMBS) are backed by residential properties.
Risks of CMBS
The main risk for CMBS investors is the possibility of loan defaults. However, since CMBS loans are nonrecourse, borrowers cannot be held personally responsible.
Main Benefit of CMBS
The main benefit for investors is reliable cash flow based on fixed interest rates. Prepayment penalties discourage early loan repayment.
In conclusion, CMBS is a type of security backed by commercial real estate loans, providing investors with reliable cash flow and borrowers with fixed interest rates.
