CMBS are Split Into Tranches Based on Credit Risk
Just like asset backed securities and mortgage backed securities (MBS), commercial mortgage backed securities (CMBS) are divided into tranches based on credit risk. The highest-rated, least risky loans will be placed in the highest tranches, while the lowest-rated, riskiest loans will be placed in the lowest tranches. Higher tranches will generally offer interest rates (and lower returns for investors), while lower tranches offer higher interest rates (and higher potential returns for investors). Investors should understand, however, that, in the case of a default on one or more loans in a commercial mortgage backed security, the highest tranches must be fully paid off, with interest, before the lower tranches will receive any funds.