Commercial Mortgage-Backed Security (CMBS)

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Paul Tracy

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Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers. While there, Paul authored and edited thousands of financial research briefs, was published on Nasdaq. com, Yahoo Finance, and dozens of other prominent media outlets, and appeared as a guest expert at prominent radio shows and i...

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Updated January 16, 2021

What is a Commercial Mortgage-Backed Security (CMBS)?

A commercial mortgage-backed security (CMBS) is a fixed-income security, typically in the form of a bond, which uses commercial real estate loans as collateral.

How Does a Commercial Mortgage-Backed Security (CMBS) Work?

A CMBS is comprised of numerous commercial mortgages of varying terms and values, such as multi-family dwellings, commercial real estate, etc. Unlike a residential mortgage-backed security (RMBS), a CMBS offers reduced pre-payment risk, since the term on commercial mortgages is generally fixed.

Investors who hold a CMBS receive, as payment, the interest and principal repayments on these mortgages. Therefore, investors principally take on the borrower's risk of default (non-repayment). Unlike residential mortgage-backed securities, however, a CMBS does not present pre-payment risk to the holder, since commercial mortgage loans are set at a fixed term.

Similar to collateralized mortgage obligation mortgage obligations (CMO), the mortgages that back the securities are classified into tranches of risk. This allows investors to purchase a CMBS that fits their risk preference. Higher tranches (usually designated as A) have a higher rate of return because they receive both interest and principal payments, but also have a greater amount of risk (if the borrower can't make the payments, the investor gets nothing). Lower tranches (usually designated as B, C, or even D) carry lower risk at a lower rate of return because they absorb only interest payments on mortgages with shorter terms to repayment.

Why Does a Commercial Mortgage-Backed Security (CMBS) Matter?

A CMBS presents a reduced-risk alternative to a RMBS, since prepayment risk is nearly eliminated. Moreover, the CMBS is a way for lending institutions to reduce risk and increase lending power by packaging outstanding debt receivables, such as mortgages, into potentially profitable securities that can be purchased by investors.

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Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about Commercial Mortgage-Backed Security (CMBS), then please ask Paul.

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