CMBS: The Ride Is Not Over Yet

Abstract

Commercial mortgage-backed securities (CMBS) did not suffer in the financial crisis the way residential mortgage-backed securities (RMBS) did. CMBS, unlike RMBS, are backed by a variety of income-producing properties. All four CMBS primary property types—office, retail, multifamily, and lodging—responded to improving economic data in 2010, albeit in varying degrees, and we expect this trend to accelerate in 2011. Along with improving operating incomes in the medium term, commercial properties should also benefit from declining capitalization rates (annual net operating income/cost or value). In addition to improving fundamentals, we expect several technical factors to prop up CMBS pricing in 2011, including limited supply and growing demand for CMBS paper. While the overall picture looks positive, several significant risks could derail CMBS performance, including an interest rate shock and slower than expected economic recovery.