Commercial real estate has been caught in the center of the perfect storm. Given its high sensitivity to interest rates, the sector came under pressure from the rapid and precipitous rise in rates. Additionally, lifestyle changes and pandemic-related shifts to hybrid and remote work led to a glut of office supply. The commercial real estate market’s impending demise has been well documented, with headline risk a frequent concern.
Yet despite all the “doom and gloom” news, commercial mortgage-backed securities (CMBS) rated BBB have outperformed Treasuries, corporate bonds, and other securitized credit sectors for the year to date through mid-February. Some of this rally in CMBS likely was triggered by market expectations that interest rates peaked with the Federal Reserve's recent pivot. Commercial real estate is one of the most leveraged sectors—making it also one of the most interest rate sensitive sectors—perhaps in the entire credit market. The pessimistic market sentiment already priced into the market and the cheap valuations provide a catalyst for a rally when the forecasted draconian scenarios do not materialize. Other factors potentially contributing to the recent rally include the tightening of bank lending standards and the lack of new issue supply.
As we discussed in our recent podcast, it is important to remember there are diversified property types within the CMBS market, including multifamily, retail, hotels, industrial, and self-storage; it is not all about offices. Each property type has its own idiosyncratic characteristics, although these may frequently be overshadowed by the extreme negative market sentiment around offices. We are not saying the market fundamentals for CMBS have bottomed yet, but we still see opportunities within the broad sector as it will take years to work out the excess supply in the office sector. At the same time, the office sector’s woes are not a market surprise anymore, nor do we expect a sudden market squeeze that would generate systemic risk. So, if the outcome for these loans turns out to be better than expected, the CMBS market could rally meaningfully.
Index Definitions
ICE BofA BBB U.S. Fixed Rate CMBS Index tracks the performance of U.S. dollar-denominated BBB-rated fixed rate commercial mortgage-backed securities publicly issued in the U.S. domestic market.
ICE BofA 7-10 Year BBB U.S. Fixed Rate CMBS Index is a subset of the ICE BofA BBB U.S. Fixed Rate CMBS Index, tracking the performance of U.S. dollar-denominated BBB-rated fixed rate commercial mortgage-backed securities with maturities of 7 to 10 years publicly issued in the U.S. domestic market.
ICE BofA AA-BBB Fixed-Rate U.S. Asset-Backed Securities Index is the AA-rated to BBB-rated subset of the ICE BofA U.S. Fixed-Rate Asset-Backed Securities Index, which tracks the performance of USD-denominated investment-grade fixed-rate asset-backed securities publicly issued in the U.S. domestic market.
ICE BAML U.S. Corporate Index tracks the performance of U.S. dollar-denominated investment grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P, and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule, and a minimum amount outstanding of $250 million.
ICE BofA U.S. Mortgage-Backed Securities Index tracks the performance of U.S. dollar-denominated, fixed-rate and hybrid residential mortgage pass-through securities publicly issued by U.S. Agencies in the domestic market. Included in the index are 30-year, 20-year, 15-year and interest-only, fixed-rate mortgage pools, provided they have at least one year remaining to final maturity and a minimum amount outstanding of at least $5 billion per generic coupon and $250 million per production year within each generic coupon.
ICE BofA Current 10-Year U.S. Treasury Index tracks the performance of U.S. dollar-denominated 10-year sovereign debt publicly issued by the U.S. government in its domestic market. It is a subset of the ICE BofA U.S. Treasury Index.
Morningstar LSTA U.S. Leveraged Loan Total Return Index is a market value-weighted index designed to measure the performance of the US leveraged loan market based upon market weightings, spreads, and interest payments.
J.P. Morgan Collateralized Loan Obligation (CLO) BB Total Return Index is a total return subindex of BB-rated securities within the J.P. Morgan Collateralized Loan Obligation Index (CLOIE), which is a market value-weighted index consisting of U.S. dollar-denominated CLOs.
ICE BofA U.S. High Yield Index tracks the performance of USD-denominated below investment grade corporate debt publicly issued in the major domestic markets.
Tracy Chen, CFA, CAIA
Portfolio Manager
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Groupthink is bad, especially at investment management firms. Brandywine Global therefore takes special care to ensure our corporate culture and investment processes support the articulation of diverse viewpoints. This blog is no different. The opinions expressed by our bloggers may sometimes challenge active positioning within one or more of our strategies. Each blogger represents one market view amongst many expressed at Brandywine Global. Although individual opinions will differ, our investment process and macro outlook will remain driven by a team approach.
