How exposed is BND to commercial real estate valuation drops

[Godzilla]

My question is whether a repricing of commercial real estate values - I'm concerned about downtown office spaces across the US - will have an effect on BND. I know it invests in mortgage debt but does it, somehow, invest in other real estate debt? I figured some of the brainiacs on the board might have a solid answer on this.

Thanks, Godzilla

[Valuethinker]

My question is whether a repricing of commercial real estate values - I'm concerned about downtown office spaces across the US - will have an effect on BND. I know it invests in mortgage debt but does it, somehow, invest in other real estate debt? I figured some of the brainiacs on the board might have a solid answer on this.

Thanks, Godzilla

US Agency bonds are, AFAIK, all residential mortgages only.

What you are looking for is CMBS in the list of holdings. Commercial Mortgage Backed Securities.

Also, potentially, bonds issued by banks are at risk - if those banks have high exposure to commercial RE (the money center banks less so, it's more the local and regional banks, as I understand the picture).

[Geologist]

You can look at the holdings of BND as well as any of us. What I see when I look is that it holds less than 2.5% in asset-backed/commercial mortgage-backed securities. Some of this is for auto loans, apartments, and credit cards. The part that is commercial mortgages is a fraction of the 2.5% but I have no interest in adding that up. Of course, there is also corporate debt associated with real estate firms, but what they do is not clear unless you investigate the specific firms (and again, the total for these firms is not great in the overall holdings, about 1%).

Edit: by the way, commercial real estate has already been dropping in many major cities, so if it is having an effect on the debt, then it is already priced into BND.

[Godzilla]

Thanks to valuethinker for your input.

[livesoft]

I think it is kind of too late to think about the valuations of commercial real estate. I will note that TIAA Real Estate Account has actually stopped dropping. That doesn't mean it will go up, but TREA generally lags reality (pun!) when it comes to valuations of its own real estate.

[Godzilla]

Thanks for the input livesoft.

But, I will briefly advocate for my concerns:

As far as I understand it commercial office space isn't as continuously valued by the market as say a stock or bond would be. And there are powerful institutions - banks, big money investors, and pension funds that may have an interest in downplaying the loss of income streams from (especially) downtown commercial real estate.
So, significantly more opaque pricing and really rich people perhaps wanting to offload risk onto everyone but themselves.

I am, more often than is comfortable, not in agreement with fellow bogleheads about what I see and what I worry about - so very likely it is a nothing burger at this point. Anyway I don't change my investment policy statement on such issues regardless. I was just seeing if anyone else is worried about this.

Thanks, Godzilla

[Northern Flicker]

The largest exposure of BND to commercial real estate likely is not through the CMBS that it holds, but through corporate bonds of banks and insurance companies with substantial exposure to commercial real estate mortgages in their own portfolios. If there is a significant increase in default rate of commercial mortgages beyond what is projected, credit spreads for corporate bonds in the finance sector could widen.

The Vanguard ETF VTC is a total corporate bond market ETF. It holds VCSH, VCIT, and VCLT in market weight proportion. This is a good proxy for the corporate bond holdings of BND. VTC is about 33% bonds in the finance sector, and BND is about 25% corporate bonds, so about 8% of the portfolio of BND is populated with corporate bonds in the finance sector.

A key point is that commercial mortgages have to do worse than already projected. Insurance companies are audited annually, and banks are both audited by an auditing firm and examined by the FDIC annually. Estimations of expected loan losses also are becoming more rigorous under CECL regulations. So the current projected impact of commercial mortgages on financial sector companies should be factored into their credit ratings and bond prices. Similar considerations would apply to CMBS, but ratings agencies and the market would be doing the analysis of credit quality.

There are of course going to be errors and imperfections in all of that credit quality analysis, but in the absence of deliberate bias, they should more or less cancel out in a diversified portfolio.

[Godzilla]

Northern Flicker!

Thanks for breaking it down re banks and insurance company debt/bonds. Yeah, I think I am worried about an echo of the subprime mortgage crisis. Fighting the last war I know but I think we all lost a lot of trust in regulatory institutions.

Godzilla

[newbie001]

If I'm reading this Green Street index correctly, it looks like public markets might suggest a upswing in private commercial real estate pending, for what that's worth:

https://www.greenstreet.com/insights/avgpremnav

[Northern Flicker]

Northern Flicker!

Thanks for breaking it down re banks and insurance company debt/bonds. Yeah, I think I am worried about an echo of the subprime mortgage crisis. Fighting the last war I know but I think we all lost a lot of trust in regulatory institutions.

Godzilla

Regulatory controls have improved since the global financial crisis of 2008/2009. That does not mean that the controls cannot fail.

If you are worried about it, you could replace BND with an intermediate treasury index fund like VGIT or SCHR. What is your percentage in bonds? Are you in or near retirement?

[Bikesy]

I think you're likely late to the game if you're trying to capitalize on softness in the commercial real estate market. This is anecdotal but I have a friend in the space and he said competition for assets has picked up substantially in the last few months. But just like the equity markets "no one knows nothing"

[Godzilla]

I have a vanilla portfolio of VTI, VXUS and BND. I am nowhere near sophisticated enough to try to capitalize on a vague concern like this. I just wanted to see if others have a worry about it as I do. I am 60, retired, 35% in fixed income - aka BND and money market.

[Northern Flicker]

I have a vanilla portfolio of VTI, VXUS and BND. I am nowhere near sophisticated enough to try to capitalize on a vague concern like this. I just wanted to see if others have a worry about it as I do. I am 60, retired, 35% in fixed income - aka BND and money market.

With money market holdings, your BND holdings are low enough that about 10% (finance sector bonds + CMBS) is probably less than 3% of your portfolio. This doesn't seem like it should be a major concern. If commercial mortgages cause issues, I think your 65% allocation to equities will be a bigger concern.

If risks like these "keep you awake at night", you may want to consider dialing back the stock allocation a little and/or moving the allocation to BND to an intermediate treasury fund like SCHR or VGIT.

[ge1]

It’s a good question, Godzilla.

As others said: The exposure to Commercial Backed Securities is minimal, only 1.8%. And the vast majority of the CMBS deals are totally fine. Let‘s assume that 10% of them wouldn’t pay anything back (which is an extreme assumption and not at all likely), it would represent .18% of the value of BND. You wouldn‘t even notice it. Swings in BND due to interest rate changes are a lot bigger.

When you read in the news that offices and certain multi family areas have lost 25% or 30% in value, remember the equity owners have typically at least that much equity in deals, so worst case the equity holders get wiped out but the bond holders are fine. And even if bond holders theoretically had losses, you wouldn’t receive 0 cents on the dollar, but maybe 85, 90 or 95.

[Valuethinker]

It’s a good question, Godzilla.

As others said: The exposure to Commercial Backed Securities is minimal, only 1.8%. And the vast majority of the CMBS deals are totally fine. Let‘s assume that 10% of them wouldn’t pay anything back (which is an extreme assumption and not at all likely), it would represent .18% of the value of BND. You wouldn‘t even notice it. Swings in BND due to interest rate changes are a lot bigger.

When you read in the news that offices and certain multi family areas have lost 25% or 30% in value, remember the equity owners have typically at least that much equity in deals, so worst case the equity holders get wiped out but the bond holders are fine. And even if bond holders theoretically had losses, you wouldn’t receive 0 cents on the dollar, but maybe 85, 90 or 95.

Interestingly there seem to be cases of 90% loss of value in commercial offices. And even some in New York/ LA/ San Francisco. SF is probably the worst hit.

[ge1]

It’s a good question, Godzilla.

As others said: The exposure to Commercial Backed Securities is minimal, only 1.8%. And the vast majority of the CMBS deals are totally fine. Let‘s assume that 10% of them wouldn’t pay anything back (which is an extreme assumption and not at all likely), it would represent .18% of the value of BND. You wouldn‘t even notice it. Swings in BND due to interest rate changes are a lot bigger.

When you read in the news that offices and certain multi family areas have lost 25% or 30% in value, remember the equity owners have typically at least that much equity in deals, so worst case the equity holders get wiped out but the bond holders are fine. And even if bond holders theoretically had losses, you wouldn’t receive 0 cents on the dollar, but maybe 85, 90 or 95.

Interestingly there seem to be cases of 90% loss of value in commercial offices. And even some in New York/ LA/ San Francisco. SF is probably the worst hit.

You're right, some of the losses have been eye popping. Would be interesting to know what the total loan volume backed by office buildings is and who is holding them but wasn't able to find that info doing a few quick google searches.

Banks have 3.0 trillion in commercial real estate loans on the balance sheet, but assume multi-family is the majority of that.