CMBS Loans for Commercial Properties
A CMBS loan, also known as a conduit loan, is a type of commercial real estate loan that is secured by a first position mortgage on a commercial property. Commercial banks, investment banks, and conduit lenders usually offer CMBS financing to CRE investors looking for higher leverage and lower fixed interest rates. Once issued, these loans are pooled together in a type of trust called a Real Estate Mortgage Investment Conduit (REMIC), securitized, and sold to investors on the secondary market.
CMBS Loans are Non-Recourse, Fixed-Rate, and Have Flexible Application Requirements
CMBS financing is non-recourse, and generally comes with fixed interest rates and amortizations of 25-30 years. CMBS loans are typically restricted to income producing properties. Conduit financing starts at $2,000,000 and up generally provide leverage up to 75% for qualified borrowers. Plus, CMBS offers cash-out refinancing, unlike many other CRE loans. In addition, unlike Fannie Mae and Freddie Mac multifamily loans, bank loans, and HUD/FHA multifamily financing, CMBS lenders typically do not put a significant emphasis on borrower net worth and real estate investment experience. Instead, they mainly look to ensure that the income from the property will be able to cover a property’s annual debt service. For this reason, minimum DSCRs of 1.20-1.25x are generally required.
In addition to looking at DSCR, and, of course, LTV, most CMBS lenders also look at a third metric; debt yield. A property’s debt yield can be determined by dividing the property’s net operating income (NOI) by the total loan amount. For instance, a property with an NOI of $1 million with a $11 million loan would have a debt yield of approximately 9.1%. Conduit lenders like debt yields of 10% or more, but some are willing to go down as far as 8% for high quality properties. Unlike DSCR, which can be increased with longer loan amortizations or interest-only payments, debt yield will only change if income or loan amount changes, making it a more reliable indicator of risk. Just like many other kinds of commercial lenders, CMBS lenders generally require borrowers to hold their property in bankruptcy-remote special purpose entities (SPEs). This reduces risk for lenders, because, if the borrower goes bankrupt, the property generally will not be involved in the bankruptcy.
CMBS Property Types and Top CMBS Lenders
Conduit loans are available for a variety of property types, including multifamily properties, apartment buildings, office buildings, hotels, retail, industrial, and self-storage properties. These loans are also available to more ‘exotic’ or unconventional property types, such as marinas, parking garages, or healthcare facilities. However, since certain types of commercial properties are considered riskier, CMBS lenders offer somewhat stricter terms. For example, lenders usually require flagged hotels to have a DSCR of 1.40x, while unflagged hospitality properties often need a DSCR of 1.50x. Depending on the situation, additional risk may also be reflected in higher interest rates.
As of 2018, the largest CMBS lenders in the U.S. included JP Morgan Chase, Deutsche Bank, Goldman Sachs, and Wells Fargo, with other top lenders including Citigroup, Morgan Stanley, Natixis, and Barclay’s. Smaller lenders still in the top ranks included Rialto, Blackstone Group, and Benefit Street Partners.
CMBS Prepayment: Yield Maintenance vs. Defeasance
While CMBS does have a wide variety of benefits for commercial real estate investors, it can be extremely difficult to prepay these loans. This is because unlike bank or life company loans, which are generally kept on a lender’s balance sheets, most of these loans are sold to investors, who are guaranteed a certain rate of return. For this reason, most conduit loan borrowers are required to pay either defeasance or yield maintenance. Defeasance involves substituting a loan’s collateral with alternative securities, in most cases, U.S. Treasury Bonds. So, instead of relying on a borrower’s loan payments to provide them income, the CMBS investors can rely on income from the bonds.
Alternately, some borrowers might be require to pay yield maintenance, which means that they will have to pay the difference between their current interest rate and U.S. Treasury yields. Yield maintenance allows the lender to make sure that they will not lose money just because the borrower is paying off the loan early. Whether a loan agreement stipulates that yield maintenance or defeasance is allowed, borrowers should be careful to note (and, if necessary) negotiate the exact terms, especially if they believe they will want to pay off their loan early.
CMBS Variations: Interest-Only, Variable Rate, and SASB Conduit Loans
While most CMBS loans are fixed-rate, partially amortizing loans pooled together in a REMIC, this is not always the case. Some conduit loans offer variable rates; and, while this may reduce interest rates in the short run, it increases overall risks for borrowers, and is not recommended in most scenarios. In many cases, however, a fixed-rate CMBS loan may be interest-only during the loan term. This greatly increases property cash flow for borrowers and also brings up a property’s DSCR, meaning that they may be able to qualify for a larger loan. In general, interest-only CMBS are very beneficial to borrowers, are are therefore quite popular. In 2018, about 50% of CMBS loans were full-term interest-only loans, and approximately 25% were partial term interest-only loans.
Finally, very large, extremely exclusive properties (think $250 million+) located in major MSAs may actually be securitized into only commercial mortgage backed security. This is referred to as a single asset, single borrower (SASB) CMBS loan. In certain cases, SASB CMBS loans have approached (and even exceeded) $1 billion.
CMBS Servicing: What Borrowers Need to Know
Another potential downside for conduit borrowers is the fact that these loans are not generally serviced by the lenders themselves; instead, they’re assigned to a Master Servicer, a company specifically tasked with servicing loans. These companies may not have a borrower’s best interests in mind as they generally work to further the interests of the CMBS investors. If a borrower has difficulty making their payments, the loan will often be sent to a Special Servicer, which may be able to modify loan terms, forgiving or deferring a certain amount of interest or fees in order to help the borrower get current on their payments. However, they will only do this if they believe it’s in the best interest of the investors; otherwise, they will likely foreclose on the property.
General CMBS Loan Terms
CMBS Loan Cons
Difficulty releasing collateral
Dealing with a master servicer may be challenging for borrowers
Secondary financing is sometimes prohibited
Loans are fully assumable
Legal fees can be particularly expensive (often $30,000 for a $3-4 million loan)
CMBS Loan Pros
Competitive rates for long-term financing
Relatively high leverage
Flexible loan sizes
Cash-out refinancing options available
Often willing to overlook credit and legal issues
Relatively relaxed borrower net worth requirements
Mezzanine financing and preferred equity may be arranged in some scenarios