While there is still uncertainty in the commercial real estate market, there are still opportunities for investors, according to asset and wealth managers. Many had hoped that interest rate cuts by the Fed would spur a sector recovery, because lower interest rates mean cheaper debt and less burdensome financing costs. But now, whether the central bank will cut rates further at all this year is in question. The central bank in December signaled two rate cuts in 2025 — and Friday's hot jobs report left Wall Street confident that interest rates will not change at the Federal Reserve's next policy meeting later this month, according to the CME FedWatch tool. The latest payroll numbers also pushed US Treasury yields to their highest levels since November 2023. Despite all that, “with volatility comes opportunity,” said Douglas Gimple, chief portfolio strategist at Diamond Hill. On top of the potential capital appreciation, investors can earn solid income from commercial mortgage-backed securities (CMBS). The iShares CMBS ETF, which tracks investment-grade CMBS, has a 30-day SEC yield of 4.04%, with an expense ratio of 0.25%. CMBS 1Y Mountain iShares CMBS ETF over the past 12 months. Even with the path of interest rates unclear, commercial real estate could be “in good shape” at current borrowing rates, said John Kirshner, head of U.S. securitized products and portfolio manager at Janus Henderson Investors. “That worst-case scenario has been somewhat pushed to the side now,” he said. However, investors must be selective when choosing assets. “In commercial real estate, it's very difficult to passively go in and buy deals without knowing what's hidden,” said Kirchner, who runs the Janus Henderson Secured Income ETF (JSI). The fund has 30% exposure to CMBS. He sees opportunity in multifamily data centers, industrial and some office mortgages. For example, among office buildings, location and construction quality are important. “The best buildings, the best neighborhoods and great amenities will be fine,” he said. JSI 1Y Mountain Janus Henderson Securitized Income ETF over the past 12 months. Data centers will be a big beneficiary of the demand for computing power created by artificial intelligence, Kirchner noted. He said that because the asset class is relatively new, it tends to have wider spreads – meaning it trades cheaply. “If the spread is wider, you'll basically be tempted to do the work and see if it makes sense for your portfolio,” he explained. Diamond Hill's Gimple likes single-asset commitments, single-borrower CMBS loans, and commercial real estate collateralized loan obligations (CLOs). The first involves a single asset – such as an office building or a luxury hotel – or a single borrower, which could be a hotel chain with multiple locations, while collateralized loan obligations are short-term, variable-rate deals. It's usually taken out by a company to upgrade a property, such as putting in a swimming pool or energy-efficient air conditioning in an apartment complex, he said. “You're looking at a spread of 200 to 300 (basis points) in the CMBS market, specifically within (single asset, single borrower) and CRE CLOs, and that's still really attractive for credit — maybe for the same or even better credit risk,” Gimbel said. “One basis point equals 1/100 of a percentage, or 0.01%. He said that with single-asset, single-borrower assets, investors get a better understanding of what they are buying compared to a channel CMBS, which are pools of loans. “You can understand the risks and opportunities more clearly,” he added. Diamond Hill's short-term collateralized bond fund (DHEIX) has 21.6% of its portfolio in securities. Non-Agency Mortgage-Backed Securities As of December 31, its largest holding in non-agency mortgage-backed securities was single-family rentals, followed by multifamily and CREs. CLOs There are also small allocations to the DHEIX 1Y Mountain Diamond Hill short-duration securitized bond fund over the past year. EYES OPEN David Gottlieb, wealth manager at Savvy Advisors, said those who want to invest in CMBS should not do so blindly, but should instead get the right financial advisor. This is because the sector is complex and there are “pretenders” in the industry. “When you're dealing with complex things like this, it's essential to consult with someone who has a proven track record, has a knowledge base, can demonstrate their acumen and then properly guide you under a fiduciary obligation,” he said. Gottlieb, who specialized in real estate investing, likes to use mortgage-backed securities for liquidity and as a hedge against real estate equity. His clients typically allocate about 5% to 10% of their fixed income portfolio to CMBS. “It's important to have it, even if it's just a small part of a fixed income portfolio — if nothing but for that liquidity factor,” he said. However, it may not be suitable for everyone. “You have to see if it's going to be a good fit for you,” Gottlieb said.
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