Why floating-rate, single-borrower CMBS look attractive

Floating-rate commercial mortgage-backed securities, especially single-borrower CMBS, have new appeal based on attractive yields and credit spreads, says Fidelity's Bill Maclay.

• Within the universe of real estate securities, Fidelity Portfolio Manager Bill Maclay is finding particularly good value these days among commercial mortgage-backed securities, especially those of the single-borrower variety.
• "Single-borrower CMBS represent a collection of similar commercial properties owned by one entity," explains Maclay, who manages Fidelity Advisor^® Real Estate Income Fund. "I like this structure because single-borrower CMBS — rather than multi-borrower CMBS — allow me to focus the fund's investments on particular property types I really like."
• In helming the fund since 2019, Maclay seeks to achieve what he considers a reasonable total return by investing in real estate stocks and bonds, aiming for a potentially higher yield and less volatility than what is typically available by investing solely in real estate investment trust common stocks.
• For quite some time, the fund has held a substantial allocation to single-borrower CMBS, mostly consisting of floating-rate securities. The coupon of these bonds varies along with the Secured Overnight Financing Rate, or SOFR, a benchmark interest rate that reflects the cost of borrowing cash overnight.
• Maclay points out that persistently high interest rates have made these floating-rate CMBS an appealing proposition, one that could remain in place for a while longer.
• "It seems like interest rates are staying higher, given the market's concern about inflation," he explains. "Moreover, the U.S. Federal Reserve appears in no rush to cut rates, which is certainly a different situation than we were all expecting six months ago. So, if SOFR stays high, then that will provide a favorable yield environment for the fund's floating-rate CMBS."
• He clarifies that much of the fund's exposure to CMBS is in bonds rated below investment grade, an area of the market where he is seeing especially good value.
• "These securities have substantial credit spreads, resulting in yields in the high single digits," he says. "Considering that these floating-rate securities also lack interest-rate risk, I think that's a particularly compelling return opportunity."
• Maclay also points out that these securities' credit risk appears manageable, given that the fund primarily owns property types he and his colleagues believe have benefited from business tailwinds, including warehouses, apartments, single-family homes and data centers.
• "I think these CMBS offer especially attractive value, particularly when compared to alternatives in the fund's investment universe, such as real estate common stocks or high-yield bonds," he concludes.