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 Flexible, Non-Recourse, and Fixed-Rate

CMBS financing is non-recourse, and it generally comes with fixed interest rates and amortizations of 25 to 30 years. CMBS loans are typically restricted to income-producing properties. Conduit financing starts at $2 million and generally provides leverage up to 75% for qualified borrowers. Plus, these loans offer cash-out refinancing, unlike many other CRE financing options. 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 primarily ensure that the income from the property will be able to cover a property’s annual debt service. For this reason, minimum DSCRs of 1.20x to 1.25x are generally required.

In addition to looking at DSCR and LTV, most CMBS lenders also look at a third metric: debt yield. 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.

Property Types Eligible for CMBS Financing

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 at least 1.50x. Depending on the situation, additional risk may also be reflected in higher interest rates.

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, which are guaranteed a certain rate of return. For this reason, most conduit loan borrowers are required to prepay via 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 income, the CMBS investors can rely on income from the bonds.

If your CMBS loan requires yield maintenance, a borrower will have to pay the difference between the loan’s interest rate and U.S. Treasury yields for the remainder of the term. 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 a 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. While this may lead to lower interest rates in the short term, 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 a borrower may be able to qualify for a larger loan. In general, interest-only CMBS vehicles are very beneficial to borrowers and are therefore quite popular.

Finally, very large, exclusive properties (think of assets valued at more than $250 million) in major MSAs may have a loan securitized by itself as a 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

A 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, which is a company specifically tasked with servicing loans. These companies may not have a borrower’s best interests in mind. Their sole remit is typically to work to further the interests of the CMBS investors.

If a borrower has difficulty making 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. If not, they will likely not hesitate to foreclose on a property.

General CMBS Loan Terms 2022

• Minimum Loan: $2 million

• Loan Term: Five-, seven-, or 10-year fixed-rate loans

• Interest Rates: Starting at 200 bps above relative Treasury

• Amortization: 30 years

• Leverage: 75% to 80% maximum LTV

• DSCR: 1.25x minimum

• Recourse: Non-recourse (with standard carve-outs)

CMBS Loan Cons 

• Difficulty releasing collateral

• Expensive to exit (long lock-out periods may require defeasance in order to exit the loan early)

• Dealing with a master servicer may be challenging for borrowers

• Reserves required

• Secondary financing is sometimes prohibited

• Loans are fully assumable

• Legal fees can be particularly expensive

CMBS Loan Pros

• Non-recourse

• Competitive rates for long-term financing

• Relatively high leverage

• Flexible loan sizes

• Cash-out refinancing options available

• Borrowers with credit and legal issues may qualify

• Relatively relaxed borrower net worth requirements

• Mezzanine financing and preferred equity may be arranged in some scenarios

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