What Drives the Return on CMBS?

Abstract

Despite the significance of commercial mortgage-backed securities (CMBS) as one of the fastest growing asset classes and the increasing interest in CMBS by institutional investors, available empirical evidence on CMBS is lacking. This article sheds light on the investment performance of CMBS, the driving forces behind CMBS return variability, and the relative importance of these variables in predicting CMBS returns. Using monthly data for the Lehman Brothers fixed income indices from January 1997 to June 2006, the author finds that mean return and total risk-adjusted return on investment-grade and high-yield CMBS clearly dominate those on investment-grade and high-yield corporate bonds, Treasuries, and stocks. The autor uses a structural vector autoregressive (VAR) model to examine what drives the excess returns on CMBS and how. Impulse response analysis suggests that the growth in industrial production, inflation rate, change in 30-year mortgage rate, change in term structure spread, and excess return on the S&P 500 all have a significant and inverse contemporaneous effects on the excess returns on investment-grade and high-yield CMBS. Variance decomposition reveals that the change in mortgage rate and the term structure spread together explain 57% and 44% of the variance in investment-grade and high-yield CMBS excess returns, respectively. Changes in the amount of CMBS issuance show a significant negative lag effect on CMBS excess returns. The required returns on CMBS are positively driven by the changes in credit spread, but this positive effect is much stronger for high-yield CMBS than for investment-grade CMBS.