Pushing Dirt

CMBS stands for commercial mortgage backed securities. Simply put, in the go go days leading up to the 2008 market nosedive, wall street originated debt (called conduit debt) and securitized it….meaning they created pools of mortgages and then sliced the sliced the cash flow thrown off the mortgages into different tranches — from AAA for the lowest risk, the first to be repaid in case of default — on down to the “B piece” at the bottom of the cash flow waterfall, with the highest risk that you’ll lose everything.

Those who have the wherewithal to make investments in the AAA CMBS securities today (accredited investors) are finding now with AAA CMBS debt they can earn double digit returns with return of principal even if a good chunk of the collateral in the pool defaults. An individual investor can invest in mutual funds that buy this kind of debt.

Hard to rationalize buying the actual sticks and bricks at a single digit cap rate considering this, huh?

The pool of commercial lender owned real estate (or real estate owned - reo) Much foreclosed commercial property today was encumbered by a CMBS loan (i.e. securitized, conduit loan). When CMBS loans go into default, a third party called a special servicer takes over. There is a small handful of special servicers nationwide assigned the duties of working out troubled loans or if necessary taking them through the foreclosure process. You need to get to know the special servicers, ideally before they need you. the mortgage bankers association should have a list with contact information (mbaa.org). call each one, ask for the person dealing with “troubled loans” and real estate owned (reo) in your state. then “farm” them (to borrow from the residential parlance), calling or emailing them periodically and offering to help with market information if they need your help.

Joe Burke, a great mortgage broker in Maryland wrote the following about the commercial mortgage market. A great read. Let me know if I can put you in touch with Joe.

“What a market we have had over the past six months! It seems things change every day. Yesterday we saw the 10 year Treasury rate plunge about 15 basis points to 3.29% in the morning only to lose steam quickly ending the day at 3.60%, a 31 basis point increase in 4 hours time. I have been in this business for a long time weathering a lot of ups and downs in the market but I cannot recall experiencing the volatility we are currently seeing. It makes it tough on both lenders and borrowers trying to figure out where we will be tomorrow and when should you think about locking rates. The volatility creates many issues for lenders who don’t want to lock rate when the Treasury is approaching historic lows unless they are sure that it is a long term trend. The lenders try and hedge their bets and typically either widen their spreads as the Treasury rates go down this quickly or institute a floor rate that they will not go below regardless of where the Treasury goes. The philosophy behind this strategy is easier to understand when viewed in the context of what happened in the Treasury market yesterday. In the space of 4 hours they could have lost 31 basis points on their ultimate rate.

Pricing pressure for insurance companies come primarily from what alternative investments are available at spreads that are equal to or better than what is available in the commercial real estate mortgage market. Currently in the CMBS market in the Super Senior traunch [which has a 30%+/- subordination level] spreads of 200-235 basis points are available. Typically rated as high as AAA by the rating agencies one can see the relative value investing in these AAA CMBS bonds. The question all real estate developers would ask is “are they really AAA?” Time will tell but it does explain why CMBS all in spreads for new business can range from 275-350.”