Hotel and retail mortgages dragging down recovery

Spreads on the BBB-rated CMBS market are higher than prior to the pandemic

Matt Salem, KKR head of real-estate credit (Getty; KKR)
Matt Salem, KKR head of real-estate credit (Getty; KKR)

Mortgages backed by hotels and retail properties are struggling — and attracting yield-hungry investors willing to tolerate the risk, the Wall Street Journal reported.

As the risk that the loans will fail increases, so does the yield of the securities into which they are bundled. One way to measure that risk is to compare that yield to what super-safe 10-year Treasury notes pay. At the moment, the difference between those two numbers, called the spread, is high.

Consider lower-rated commercial mortgage-backed securities — those rated BBB, or one level above what’s commonly called junk status.

The spread for an index tracking the BBB-rated CMBS market and the 10-year Treasury note was 5.1 percentage points on Thursday. Although that’s a far cry from the 11.2-point spread in April, it is still more than twice the 2.4-point spread before the pandemic, according to the Journal.

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For CMBS indexes that include more hotel and retail properties — CMBX 9 and CMBX 6, respectively — the spreads reached close to their April and May highs on Wednesday.

The spreads are rising as more loans run into trouble. About 8.8 percent of outstanding commercial loans were delinquent as of last week, according to Trepp, the Journal reported.

Some investors are seeing the higher spreads as an opportunity. KKR recently closed a $950 million fundraising round for its second real estate fund that is investing in single-B newly issued deals. Matt Salem, KKR’s head of real estate credit, told the Journal he is optimistic because the commercial real estate market has rebounded quickly.

CMBS loans are viewed as riskier than traditional loans because the agreements that the servicers of the loans have with bondholders make them more difficult to restructure. [WSJ— Keith Larsen

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