As real estate markets no longer seem to be operating disconnected from other capital markets, the value and reason for holding commercial mortgage-backed securities is undergoing some radical changes.

The real estate market is becoming more in tune to the demands of bond buyers, with banks and insurance companies, and that is causing property markets to perform almost in the same cycle as other fixed-income asset classes.

"If real estate as an asset class begins to perform in a way that correlates more highly with other fixed-income instruments, that affects how investors use real estate in a mixed-asset portfolio," said Sally Gordon, vice president and senior analyst at Moody's Investors Service. She is also the author of a report on this topic.

"A lot of people have always thought real estate, because it didn't correlate with other things, has diversification value in a portfolio. But if it loses some of that diversification value, it reduces some of the reasons for buying the stuff in the first place," Gordon said.

Throughout history, the real estate market has performed well in times of economic downturn, and horribly during periods of economic growth. This time around, the current real estate cycle is not relying on history.

Presently, 20% of commercial mortgages are being placed into securities - up from 5% in 1990 - enabling investors to move in and out of the market very quickly, not paying strict attention to the performance of the real estate itself.

And with investors paying more attention to their yield and coupon payment date, banks are changing their policies and making it harder for borrowers to prepay their mortgages. The options borrowers have are affected by bond market constraints, not real estate factors.

"Bond buyers want predictability," Gordon said. "They're matching those bonds against other liabilities that they have. As a result, mortgages have terms and conditions in them that in effect increase the predictability of cash flow to bond buyers."

Banks that sell mortgages into a trust no longer own that mortgage, so they enact stiff penalties on those wishing to refinance or readjust the mortgage to make improvements to the property.

"Borrowers in some cases are rethinking how they manage the financing of their real estate," Gordon said.

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