CMBS for the Distressed

It's not news that US office buildings are in a bit of trouble, but the scale of this issue is breathtaking. Office building owners are trying to refinance $117bn of commercial mortgages (ouch!) that are due in 2024, but they're having a hard time with the high interest rates. Most of these mortgages were taken out a decade ago when rates were lower, but now that rates have gone up, the buildings aren't performing as well. This puts investors at risk of losing billions of dollars.

It's worth noting that commercial mortgages are different from home loans. With a home loan, monthly payments go towards both principal and interest, but with commercial mortgages, it’s mostly just the interest. The only time the principal is paid occurs on the day the mortgage comes due, which makes things tricky.

The impact of the COVID-19 pandemic has definitely adversely affected the situation, with more people working from home, resulting in more office vacancies leading to less money coming in for building owners, thus creating a snowball effect.

With so much distress in the commercial real estate market, relief measures have been cropping up in the form of commercial mortgaged backed securities (CMBS). CMBS bonds typically pays more than government debt or similarly rated corporate bonds and are held by insurance companies, pension funds, and individual investors.

There are now roughly $800bn in CMBS in the US. Delinquencies on office loans that are being financed by CMBS topped 6% at the end of November, up from 1.7% one year earlier, according to real estate data firm Trepp.

The role of CMBS in this market has been to spread out the risk, and so far it seems to be doing just this.

#distress