Commercial properties located in smaller U.S. cities pose a greater risk to investors than similar assets in larger cities, according a report by Moody’s Investors Service "U.S. CMBS Loan Performance: Impact of Seasoning, Leverage and Location on Probability of Default." The ratings agency examined 40,000 commercial real estate loans underlying CMBS deals that are valued at nearly $330 billion from 1995 to 2003.

"The smaller the U.S metropolitan statistical area (MSA), the greater the default probability for real estate underlying commercial mortgage-back securities (CMBS) and this holds true even when building debt is controlled for," says Moody’s analyst Sally Gordon.

Why would this be the case? Moody’s speculates that loans in larger MSAs have more poor-performing assets such as healthcare facilities, while large MSAs have bigger, institutional quality office buildings. Historically, studies have found that larger loans generally perform better than smaller ones, often because they are more conservatively underwritten with lower leverage.

"Another major finding was that traditional life insurance experience for delinquencies in commercial real estate shows that delinquencies tend to have a hill-shaped curve, peaking in years three to seven before starting to decline," says Gordon.

CMBS delinquencies do not fit the same profile, according to Gordon. Several factors could be responsible for the difference: First, life companies can avoid foreclosing troubled loans since there are many alternatives open to them. Also, CMBS portfolios and life company portfolios are composed of differing property classes.

"Non-core property types such as hotels and healthcare tend to continually experience increases in delinquency over time, showing none of the deceleration that accompanies loan seasoning in life company portfolios and other property types in CMBS," adds Gordon.