Commercial mortgage bonds are experiencing the largest rally in 10 months on growing confidence that declining unemployment will boost the economy enough to stem a tide of loan defaults. Top-rated securities backed by U.S. property loans returned 1.41% in April, while AAA-ranked corporate bonds gained 1.28%, a gap of 0.13 percentage points, the biggest since January, according to Bank of America Merrill Lynch index data. In March, corporates returned 0.07% versus 0.02% for bonds tied to skyscrapers, hotels, apartments and shopping centers.
The $700-billion market for commercial mortgage debt is gaining favor as a 45% decline in real estate values since 2007 slows and the jobless rate drops to a two-year low. The balance of delinquent loans bundled and sold into bonds fell in March for the first time in more than three years. On May 1, Warren Buffett said that prices have been “pretty strong” in multifamily real estate.
“As we’ve seen the employment picture improve, people feel better about taking the worst-case scenario off the table,” said James Grady, a managing director at Deutsche Asset Management in New York, which has $240 billion in assets under management including commercial-mortgage debt. “Vacancy and lease rates are starting to improve, and that supports prices in commercial real estate.”
Relative yields on AAA-ranked commercial mortgage securities have fallen to 173 basis points, or 1.73 percentage points, the lowest since January 2008, according to Bank of America Merrill Lynch data. The index ended 2010 at 200 basis points.