The future of Commercial Mortgage-backed Securities

Let me start by defining CMBS: “Commercial Mortgage-backed Securities”. It is a type of bond created by pooling a bunch of mortgage loans issued against commercial properties.

Everyone knows that banks do not want to own real estate, but they actually do not even want to own the mortgage notes. Banks prefer to initiate a loan and make money from the associated expenses like origination points and servicing fees.

Once banks approve and issue a loan they just want to get it off the books so they bundle these loans and sell them, for their secured income streams, to an investment bank in a form of a single bond.

The investment bank partitions the bond into different pools based on the quality of the underwriting: the low-risk borrowers, the high-risk borrowers, and so on. Then they sell them to investors via the securities market.

This process creates liquidity with variable levels of risk to the investors that end up with these pools of mortgages.

So to summarize, mortgage-backed securities free up bank money and give investors an opportunity to invest in secured income streams based on the quality of the loans created and packaged.

The lack of liquidity problem today is caused by the debt crisis both in the United States and Europe, and the short-term future of CMBS still looks bleak.

There is no liquidity and both bankers and investors are worried about the market direction. This is creating a lack of liquidity for borrowers trying to get commercial loans and is tightening the market.

The good news is one can then focus on buying non-performing loans at huge discounts after performing the proper due diligence and handle a workout plan with defaulted borrowers based on:

• The discount price at which one can purchase the Note
• The location of the property
• The value of the property
• The note quality (the underwriting)
• The borrower quality
• The terms that could be worked out

Smart investors adjust quickly to the market changes and are able to find better entry points and exit points as they see the tightening and loosening of all mortgage-backed securities whether they are CMBS (Commercial mortgage-backed securities) or RMBS (Residential mortgage-backed securities).

According to several experts, the market will improve once most of the foreclosures are released and absorbed into the market (the absorption is directly related to employment and market stability) and the European debt crisis is handled. This will most likely take time all the way till the summer of 2015 if not longer.

This could be good news if you know how to invest in non-performing notes or bad news if all you know is how to invest in a traditional liquid market.

Wishing you smart investing in mortgages.

Cherif Medawar

Founder CMREI