Warning signs for commercial mortgage-backed securities

| September 08, 2023

Remember the financial crash of 2007-08 that began with the collapse of mortgage-backed securities? I won’t say we’re on the precipice of anything that drastic, but it’s time to take a look at your exposure to commercial mortgage-backed securities, or CMBS.

Commercial mortgage-backed securities, a $1 trillion market, are essentially bonds paying a fixed rate. They’re created by banks and financial services firms, which package their commercial mortgages for purchase by investors. These are mortgages for commercial buildings such as office buildings and strip malls instead of residential homes.

One of the consequences of the pandemic was an increase in remote work. Many office buildings that bustled with activity pre-COVID suddenly became giant dust catchers. There’s been some movement back to the office, but it seems like hybrid work arrangements are here to stay. Coupled with fewer people shopping at retail centers and—in what might be the biggest problem—many commercial owners of multifamily residential buildings facing much higher interest rates in the coming months, commercial real estate is feeling the strain.

You probably don’t own CMBS directly, but there’s a good chance they’re in your portfolio indirectly. Institutional investors, who make large transactions of stocks, bonds, and other investments, might employ them in their holdings. So CMBS could be in your mutual funds, especially bond funds, or any alternative investments, such as private-equity or hedge funds. There are also mutual funds and exchange-traded funds (ETFs) that focus on CMBS.

On the plus side, CMBS provide a steady source of income. The penalties for prepaying the mortgages in CMBS also mean an increased chance the cash flow will continue through the term of the loan. On the negative side, there’s the risk of defaults.

You can see some of the pain in CMBS in the iShares CMBS ETF, which is at a historical low since peaking in 2020-21. I’m not someone who regularly predicts disaster, and I do believe that in the long run, there will be opportunities that arise from the current difficulties for CMBS.

For sure, you can’t paint all commercial mortgages with the same brush. Some are in better position than others. But it’s time to talk to your financial advisor about your exposure to commercial mortgage-backed securities. If you have investments that rely significantly on the performance of this sector, consider making a switch.

You might see commentary suggesting that investors have learned their lessons from past mistakes regarding mortgage-backed securities. I wouldn’t be so sure. I’ve found that some industries are better than others at learning lessons. Some industries make the same mistakes over and over, sometimes out of hubris, sometimes from a historical lack of good management.

Investors, however, need to learn from their mistakes. There’s no reason to panic, but don’t let too much exposure to CMBS cause problems for your portfolio.

Sources:

https://www.dividend.com/fixed-income-channel/cmbs-bonds-assessing-the-risks-and-exploring-opportunities/

https://www.morningstar.com/alternative-investments/commercial-real-estate-is-trouble-not-reason-you-think

https://www.investopedia.com/terms/c/cmbs.asp

https://mortgageorb.com/commercial-mortgage-delinquency-rates-rise-in-second-quarter



Evan R. Guido is the Founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com.   Read more of his insights at https://finance.heraldtribune.com/category/ask-guido/. Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC.  Investment advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through  an Avantax affiliated insurance agency.  6260 Lake Osprey Dr. Lakewood Ranch, FL 34240.  The views and opinions presented in this article are those of Evan R. Guido and not of Avantax Wealth Management® or its subsidiaries.  Past performance does not guarantee future results. The S&P 500 is an index of 500 major, large-cap U.S. corporations. Standard & Poor's is a corporation that rates stocks and corporate and municipal bonds according to risk profiles. The S&P 500 is an index of 500 major, large-cap U.S. corporations. You cannot invest directly in an index.  An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency.  Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.  CDs are FDIC insured and offer a fixed rate of return.  They do not necessarily protect against a rising cost of living.  The FDIC insurance on CDs applies in case of insolvency of the bank, but does not protect market value.  Other investments are not insured and their principal and yield may fluctuate with market conditions. Investments are subject to market risks including the potential loss of principal invested. In general, bond prices rise when interest rates fall, and vice versa.  This effect is usually more pronounced for longer-term securities.  You may have a gain or loss if you sell a bond prior to its maturity date.