CMBS B-Pieces and The Multifamily and Commercial Lending Market
CMBS loans are among the most popular types of financing for multifamily and commercial real estate, with approximately $77 billion in CMBS financing issued in 2018 alone. As many already know, CMBS loans are designed for securitization, meaning that one borrower’s loan will generally be grouped with many others to generate a commercial mortgage-backed security, which is then sold to investors on the secondary market.
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CMBS loans are among the most popular types of financing for multifamily and commercial real estate, with approximately $77 billion in CMBS financing issued in 2018 alone. While these loans are popular, the underlying financial structure of the debt can be complicated. As many already know, CMBS loans are designed for securitization, meaning that one borrower’s loan will generally be grouped with many others to generate a commercial mortgage-backed security, which is then sold to investors on the secondary market. However, not all of these securities are the same; instead, they are divided between multiple classes or tranches; the most significant difference being between A-class bondholders and B-piece bondholders. B-piece bondholders receive higher compensation but need to wait until all A-class bondholders are fully paid before they see any income.
Furthermore, both A-class and B-piece CMBS are divided into multiple tranches themselves. A-class bonds generally include tranches AAA/Aaa through BBB-/Baa3 (considered investment-grade debt), while B-piece tranches typically range from BBB+/Ba1 through B-/B3 (considered sub-investment grade debt).
Does This Impact CMBS Borrowers?
The information above might not seem applicable to the average commercial investor looking to take out a loan on an apartment building or office plaza, but it’s a lot more relevant than one might think. Interestingly enough, a sizable portion of CMBS that are sold to investors are B-piece bonds. For that reason, B-piece bonds have a serious impact on the price, availability, and even the terms of CMBS debt. As another point of interest, the Dodd-Frank Act, which was designed to bring stability to American financial markets, mandates that B-piece CMBS investors keep their bonds for at least five years. That way, traders and hedge funds can’t merely purchase these riskier securities to trade them later. The Act also stipulates that conduit lenders need to keep 5% of their loans on their books. These rules, combined, mean that CMBS lenders have needed to uphold stricter underwriting standards than they did in past years (i.e., in the run-up to the 2008 financial crisis).
Related Questions
What is a CMBS B-Piece?
A CMBS B-Piece is a sub-investment grade security that is part of a commercial mortgage backed security (CMBS). These securities are typically divided into two categories; investment grade securities (AAA/Aaa through BBB-/Baa3) and sub-investment grade securities (BB+/Ba1 through B-/B3). B-piece bondholders must wait until all A-class bondholders are fully paid before they receive any compensation, but they offer investors significantly higher returns when compared to A-rated CMBS.
For more information, please see CMBS B-Pieces: What You Need to Know and CMBS Loans.
How does CMBS B-Piece investing work?
CMBS B-Piece investing works by pooling together CMBS loans to create commercial mortgage backed securities. These securities are divided into several different tranches, which can broadly be grouped into two categories; investment grade securities, (AAA/Aaa through BBB-/Baa3) and sub-investment grade securities (BB+/Ba1 through B-/B3). A-class bondholders are paid first, while B-piece bondholders must wait until all A-class bondholders are fully paid before they receive any compensation. Due to their higher risk, however, B-piece CMBS offer investors significantly higher returns when compared to A-rated CMBS.
The Dodd-Frank Act mandates that CMBS lenders keep at least 5% of a loan on their books, and also require that B-piece buyers hold onto their investment for a minimum of 5 years. This means that hedge funds and other players who were actively trading B-piece securities can no longer do so.
What are the benefits of investing in CMBS B-Pieces?
Investing in CMBS B-Pieces can be beneficial for investors because they are typically higher-yielding than other CMBS securities. Additionally, the Dodd-Frank Act has mandated that B-piece buyers must hold onto their investment for a minimum of 5 years, which can provide investors with a more stable return. Furthermore, the Act also stipulates that conduit lenders need to keep 5% of their loans on their books, which can help to ensure that CMBS lenders uphold stricter underwriting standards than they did in past years.
What are the risks associated with CMBS B-Piece investing?
CMBS B-Piece investing carries a number of risks, including the risk of default, prepayment risk, and the risk of a decrease in the value of the security. Default risk is the risk that the borrower will not be able to make payments on the loan, resulting in a loss for the investor. Prepayment risk is the risk that the borrower will pay off the loan early, resulting in a loss of interest payments for the investor. Finally, the value of the security may decrease due to changes in the market or other factors, resulting in a loss for the investor.
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How does the multifamily and commercial lending market affect CMBS B-Piece investing?
The Dodd-Frank Act, which was designed to bring stability to American financial markets, mandates that B-piece CMBS investors keep their bonds for at least five years. This means that hedge funds and other players who were actively trading B-piece securities can no longer do so. Additionally, the Act stipulates that conduit lenders need to keep 5% of their loans on their books. These rules, combined, mean that CMBS lenders have needed to uphold stricter underwriting standards than they did in past years (i.e., in the run-up to the 2008 financial crisis).
The new rules have shifted the market somewhat, but the impact has not been negative— at least not yet. The availability and price of CMBS loans is directly related to the market demand for these securities, so the CMBS B-Piece market has a serious impact on the multifamily and commercial lending market.
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What are the current trends in the multifamily and commercial lending market?
According to Freddie Mac®’s predictions, multifamily origination volume is estimated to expand to $317 billion in 2019, a nearly 4% increase from the approximate $305 billion of multifamily financing originated in 2018. Factors that can be attributed to this trend include consistent investor demand for apartment properties, as well as other market forces, including a strong economy, reasonable job growth, and low interest rates.
Despite rising interest rates, Janover data reveals a steady stream of inquiries for commercial financing. Multifamily markets with steady rent increases, driven by positive demographic and employment trends, are expected to see the most activity, both in terms of transactions and new development. Nonetheless, investors will likely embrace the flight-to-quality strategy, as cap rates are expected to rise at a faster pace for Class B and C assets, resulting in less accommodative financing for value-add deals, CBRE research noted.
Looking at Janover’s proprietary lending data, it is clear that borrower sentiment is deeply impacted by current economic and macro-financial conditions, causing some investors to pause and others to move ahead at a faster pace. “The hope is that inflation will tamper, and the Fed will begin lowering interest rates towards the end of the year and into 2023. This will ultimately result in higher achievable leverage on bridge, construction, and permanent financing,” Beattie said.