A CMBS and CDO Primer

Parke Chapman wrote a primer in the National Real Estate Investor on CMBS, CDO and the commercial debt markets.

Some highlights:

Q: What led to the formation of the first commercial real estate CDO in 1999?

A: Commercial real estate CDOs were a major innovation in part driven by the need to diversify risk after the 1998 Russian financial crisis sparked a global liquidity crunch. Unlike CMBS, which adhere to strict rules on the type and quality of collateral, the commercial real estate CDO market allowed lenders and investors to introduce a debt vehicle with more flexibility. What this means is that commercial real estate CDO managers can swap collateral out of the pool, making these highly managed pools of debt.

Q: What types of loans back CMBS and commercial real estate CDOs?

A: Two key differences center on the fixed- and floating-rate nature of the collateral. Commercial real estate CDOs are typically backed by floating-rate loans whereas CMBS collateral is backed by first-mortgage loans. A commercial real estate CDO can be backed by all sorts of collateral. CMBS, preferred equity and construction loans are commonly held by commercial real estate CDOs. REIT bonds and various other types of exotic debt such as second-lien loans and unsecured debt can get lumped into these pools.

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