CMBS is a sector in which we have always maintained very conservative underwriting standards and have generally stayed senior and defensively positioned. That approach is proving appropriate given the significant headwinds facing commercial real estate (CRE) today. The confluence of higher Treasury rates, increasing risk premiums demanded by CRE investors, and capital rationing away from CRE continues to limit capital markets activity. Interest rates on the CRE loans backing CMBS continue to trend higher: One recent conduit CMBS was backed by loans with a 7.2 percent interest rate, compared to 5.9 percent in early 2023 and 3.4 percent in early 2022. Elevated financing costs discourage new CRE transactions and refinancings, and 12-month CRE property sales volume is approximately 50 percent lower than the prior year, with virtually no price discovery in stressed submarkets, such as the Los Angeles office sector. The percentage of CMBS loans that are delinquent in payment has inched up year over year but remains well below the levels seen during the COVID pandemic.
Unlike most other sectors, market technicals are not providing much support as decreasing demand for CMBS credit risk offsets lower new supply of CMBS bonds. CMBS issuance is down 75 percent year over year, with just $19 billion brought to market in the first half of 2023, compared to $75 billion in the first half of 2022. We are negative on structurally subordinated CMBS as well as office loan exposure, and while we are generally defensive in the sector, we favor senior CMBS securities in the 6.5–8.5 percent yield range, with enough credit enhancement to absorb losses should hard-to-predict property problems arise at challenging points in the cycle.
Property performance dispersion is increasing: Former trophy properties in underperforming markets are being sold or reappraised at 60–80 percent discounts, while other favorably positioned and capitalized properties quietly continue to perform. Year to date, approximately 650 of the 9,500 CMBS bonds outstanding have experienced ratings downgrades, largely related to structurally subordinated CMBS bonds with leveraged exposure to one or more properties experiencing negative credit events, such as the loss of a large tenant. This downgrade wave reminds us that CMBS investor outcomes can vary greatly from deal to deal, and even from tranche to tranche.
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This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.
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*Assets under management is as of 3.31.2024 and includes leverage of $14.5bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors, LLC.