What are 'Commercial Mortgage-Backed Securities (CMBS)'

Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security that is secured by mortgages on commercial properties, instead of residential real estate. A CMBS can provide liquidity to real estate investors and commercial lenders. As with other types of MBS, the increased use of CMBS can be attributable to the rapid rise in real estate prices over the years.

Because CMBS are not standardized, there are a lot of details associated with them that makes their valuation difficult. However, when compared to a residential mortgage-backed security (RMBS), a CMBS provides a lower degree of prepayment risk because commercial mortgages are most often set for a fixed term.

CMBS Structure

The underlying loans that get securitized into CMBS include loans for properties such as apartment complexes and buildings, factories, hotels, office buildings and shopping malls. CMBSs are a group of commercial loans on these property types that are bucketed into various tranches. Though these securities are customized, generally they have three or four tranches. Tranches are typically ranked from senior, or highest quality, to lower quality. The highest quality tranches will receive both interest and principal payments and have the lowest risk. The securities are structured so as the tranches go down in rank, they take on more risk and are designed to absorb most of the potential losses that can occur over the life of the security. The lowest tranche in a CMBS's structure will contain the riskiest loans of the portfolio and possibly speculative loans. This securitization process is important for both banks and investors. It allows banks to issues more loans in total, and it gives investors easy access to commercial real estate while giving them more yield than traditional government bonds. Typically, only very wealthy investors invest in CMBS because there aren't many options for the average investors. Though many real estate mutual funds invest a portion of their portfolio into CMBS, it is difficult to find any mutual funds or exchange-traded funds that solely invest in the asset class. The CMBS market accounts for approximately 2% of the total U.S. fixed-income market.

CMBS Participants

CMBSs are complex securities and require a wide range of market participants. Among some of the entities involved with CMBS are the investors, primary servicer, master servicer, special servicer, directing certificate holder, trustees and rating agencies. Each of these market participants has a different role that ensures the CMBSs function properly. As of December 2016, the SEC and FINRA have introduced new regulations that mitigate the risk of these securities by creating margin requirements for covered agency transactions including collateralized mortgage obligations.

BREAKING DOWN 'Commercial Mortgage-Backed Securities (CMBS)'

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