Debt investors see strong CMBS relative value play

Basis Investment Group's Tammy Jones says commercial mortgage back securities offer a chance for higher yields in a risk-off environment, but the opportunity is transitory.

Commercial real estate debt investors are seeing a strong relative value play in the US commercial mortgage-backed securities market.

While there are ample opportunities to deploy preferred equity and mezzanine debt to fill financing gaps in today’s capital-constrained markets, New York-based manager Basis Investment Group is spending more time on the CMBS market.

Tammy Jones, Basis Investment Group

The firm acquired the non-investment grade bonds of BANK5 2023-5YR1, a $1.02 billion securitization of five-year CMBS loans originated by Wells Fargo, Citibank, Morgan Stanley and Bank of America. The deal is backed by first mortgages on 134 office, retail, multifamily, hotel and self-storage properties throughout the US.

In its analysis, Basis compared the leverage and yields on the B-piece with similar metrics for preferred equity or mezzanine debt, says Tammy Jones, founder and chief executive. A key part of this analysis is the fact that this deal, like other CMBS conduits, is comprised entirely of first mortgages.

“We are looking to find good risk-adjusted returns for our investors,” Jones says, noting the firm has the ability to invest across the capital stack. “When you look at where B-pieces are trading relative to mezzanine debt and preferred equity, and consider that mezzanine debt and preferred equity are higher leverage than the first mortgages [in the CMBS pool], it is a chance to get higher yields while still being a part of a first mortgage.”

The weighted average LTV in the pool is in the range of about 55 percent, compared with about 75-80 percent for mezzanine debt or preferred equity investments. “It is very appealing in a risk-off environment, especially for a fund like ours which focuses on attractive risk-adjusted returns and preservation of capital,” Jones says.

She notes, however, that this specific opportunity is somewhat transitory, given the historical movement in CMBS loan-to-value ratios. “There are times when CMBS is much more aggressive and leverage is pushing the high 60 to low 70 percent range in some deals and the timing is important,” she says.

New York-based manager Harbor Group International has been active in the secondary CMBS markets for similar reasons. “We continue to see relative value and are buying mainly triple-A bonds,” says Richard Litton, president. “There continue to be opportunities where owners of those fixed-income instruments need to sell for whatever reason.”

The firm sees an opportunity to be active in the new issue market, with Litton highlighting how pending commercial real estate collateralized loan obligations as well as new CMBS deals are filling up the pipeline. “We continue to play in that space as well,” he says.

What’s next

Looking ahead, Jones believes it is important to keep a flexible approach and sees opportunity despite current challenges. Ultimately, buyers, sellers and lenders will have to move ahead as the market faces an estimated $1.5 trillion of maturities over the next two years.

“I formed my firm during the GFC, and I see opportunity where others may not,” says Jones. “We are in a mini banking crisis, we are seeing recessionary trends and we have rates that are much higher than the last decade of almost free money,” Jones says.

“Volumes are down because we are not yet at a level where buyers and sellers will begin to capitulate. That says there are many opportunities in both debt and equity, and Basis has the capital to transact.”