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Commercial Real Estate Glossary
Last updated on Nov 25, 2022
3 min read

Securitization in Commercial Real Estate

Securitization is the process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Not all types of commercial real estate loans are securitized, but many are.

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In this article:
  1. What Is Securitization?
  2. What Are the Benefits of Securitization?
  3. What Are the Drawbacks of Securitization?
  4. Related Questions
  5. Get Financing

What Is Securitization?

Securitization is the process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Not all types of commercial real estate loans are securitized, but many are. For instance, CMBS and conduit loans are always securitized and sold as commercial mortgage-backed securities. Many HUD multifamily loans and Fannie Mae®/Freddie Mac® loans are also securitized.

What Are the Benefits of Securitization?

Securitization has a variety of benefits, but they aren’t always obvious to the borrower. Securitization primarily benefits lenders, as they can remove most or all of a borrower’s debt from their balance sheets once they have sold it on the secondary market. This reduces the amount of risk they carry and permits them to make more loans. This can increase liquidity in the market, which (albeit indirectly) can make it easier for commercial real estate borrowers to get loans in the first place. In addition, that increase in market liquidity may also eventually bring down interest rates for borrowers — though this doesn’t always happen.

What Are the Drawbacks of Securitization?

The main drawback of securitization comes in the form of increased prepayment penalties. When a commercial real estate loan is securitized, it is no longer held by a lender. Instead, the financing is held by investors which have purchased the debt as an income-generating asset — and they will take steps to ensure they receive the returns they’ve been promised.

They don’t have personal relationships with borrowers, as a local bank or lender might, and they have no incentive to cut them a break if they wish to repay the loan early. For borrowers, that means high prepayment penalties and strict rules about how and when loans can be repaid. In many cases, securitized debt won’t just incur a high prepayment penalty, it will often have to be repaid via the process of defeasance.

Defeasance involves replacing the remaining amount of debt with securities (such as U.S. treasury bonds) that will provide investors with an equal or greater amount of income over the remaining term of the loan. Defeasance can be expensive and time consuming — and, in most cases, borrowers will have to hire an outside expert to ensure the process goes smoothly.

Another drawback of securitization is that it’s much harder for a borrower to get any form of assistance if their property goes through a financial rough patch and they have trouble keeping up with loan payments. Because securitized loans are no longer owned by the original lender, and — especially if the loan is packaged with hundreds (or thousands) of other commercial loans — there is little incentive for investors, servicers, or other relevant parties to provide any kind of relief for an individual borrower.

Related Questions

What is securitization in commercial real estate?

Securitization is the process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Not all types of commercial real estate loans are securitized, but many are. For instance, CMBS and conduit loans are always securitized and sold as commercial mortgage-backed securities. Many HUD multifamily loans and Fannie Mae®/Freddie Mac® loans are also securitized. Securitization has a variety of benefits, but they aren’t always obvious to the borrower. Securitization primarily benefits lenders, as they can remove most or all of a borrower’s debt from their balance sheets once they have sold it on the secondary market. This reduces the amount of risk they carry and permits them to make more loans. This can increase liquidity in the market, which (albeit indirectly) can make it easier for commercial real estate borrowers to get loans in the first place. In addition, that increase in market liquidity may also eventually bring down interest rates for borrowers — though this doesn’t always happen.

How does securitization work in commercial real estate?

Securitization is the process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Not all types of commercial real estate loans are securitized, but many are. For instance, CMBS and conduit loans are always securitized and sold as commercial mortgage-backed securities. Many HUD multifamily loans and Fannie Mae®/Freddie Mac® loans are also securitized.

Securitization has a variety of benefits, but they aren’t always obvious to the borrower. Securitization primarily benefits lenders, as they can remove most or all of a borrower’s debt from their balance sheets once they have sold it on the secondary market. This reduces the amount of risk they carry and permits them to make more loans. This can increase liquidity in the market, which (albeit indirectly) can make it easier for commercial real estate borrowers to get loans in the first place. In addition, that increase in market liquidity may also eventually bring down interest rates for borrowers — though this doesn’t always happen.

What are the benefits of securitization in commercial real estate?

Securitization has a variety of benefits, but they aren’t always obvious to the borrower. Securitization primarily benefits lenders, as they can remove most or all of a borrower’s debt from their balance sheets once they have sold it on the secondary market. This reduces the amount of risk they carry and permits them to make more loans. This can increase liquidity in the market, which (albeit indirectly) can make it easier for commercial real estate borrowers to get loans in the first place. In addition, that increase in market liquidity may also eventually bring down interest rates for borrowers — though this doesn’t always happen.

Advantages of Securitization for the Commercial and Multifamily Real Estate Industry: The Benefits of Securitization

  • Securitization makes it easier for a borrower to get a commercial or multifamily real estate loan.
  • Securitization allows for those loans to be offered on better terms, due to the fact that risks are split between multiple investors, instead of being held by one lender.
  • A lender must keep at least 5% of a loan on its balance sheet, which creates an incentive for lenders to avoid making loans they know a borrower will not be able to repay.

What are the risks associated with securitization in commercial real estate?

The main risk associated with securitization in commercial real estate is increased prepayment penalties. When a commercial real estate loan is securitized, it is no longer held by a lender. Instead, the financing is held by investors which have purchased the debt as an income-generating asset — and they will take steps to ensure they receive the returns they’ve been promised. This means high prepayment penalties and strict rules about how and when loans can be repaid. In many cases, securitized debt won’t just incur a high prepayment penalty, it will often have to be repaid via the process of defeasance, which involves replacing the remaining amount of debt with securities (such as U.S. treasury bonds) that will provide investors with an equal or greater amount of income over the remaining term of the loan. Defeasance can be expensive and time consuming.

Another risk of securitization is that it’s much harder for a borrower to get any form of assistance if their property goes through a financial rough patch and they have trouble keeping up with loan payments. Because securitized loans are no longer owned by the original lender, and — especially if the loan is packaged with hundreds (or thousands) of other commercial loans — there is little incentive for investors, servicers, or other relevant parties to provide any kind of relief for an individual borrower.

What are the different types of securitization in commercial real estate?

The different types of securitization in commercial real estate include CMBS loans, HUD multifamily loans, and Fannie Mae®/Freddie Mac® loans. These loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Securitization has a variety of benefits, but they aren’t always obvious to the borrower. Securitization primarily benefits lenders, as they can remove most or all of a borrower’s debt from their balance sheets once they have sold it on the secondary market. This reduces the amount of risk they carry and permits them to make more loans. This can increase liquidity in the market, which (albeit indirectly) can make it easier for commercial real estate borrowers to get loans in the first place. In addition, that increase in market liquidity may also eventually bring down interest rates for borrowers — though this doesn’t always happen.

How can securitization be used to finance commercial real estate projects?

Securitization is a process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. This process can be used to finance commercial real estate projects by providing lenders with the ability to remove most or all of a borrower’s debt from their balance sheets once they have sold it on the secondary market. This reduces the amount of risk they carry and permits them to make more loans, which can increase liquidity in the market and make it easier for commercial real estate borrowers to get loans. In addition, that increase in market liquidity may also eventually bring down interest rates for borrowers.

Source
In this article:
  1. What Is Securitization?
  2. What Are the Benefits of Securitization?
  3. What Are the Drawbacks of Securitization?
  4. Related questions
  5. Get Financing
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  • Securitization
  • Commercial Mortgage Backed Security
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  • Conduit Loans
  • HUD Multifamily
  • FHA Multifamily

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