A CMBS loan, also known as a conduit loan, is a type of commercial real estate financing that is provided by lenders who package and sell mortgages on to commercial mortgage-backed securities (CMBS) investors. These investors then receive the mortgage payments from borrowers. CMBS loans can be advantageous because they don’t require much scrutiny of a borrower. Rather, the loan is underwritten on the financial strength of the asset held as collateral.

CMBS loans are generally provided with fixed interest rates and have terms of five to 10 years, with amortization periods of up to 30 years. CMBS loans are available for most types of commercial real estate assets, but they may be harder to come by in smaller markets. This type of loan can be used to fund an acquisition or for a refinance.

CMBS loans differ from other commercial real estate financing options in that they are generally easier to get approved for, and will usually offer rates very competitive with bank financing (if not substantially better). Banks will generally put a lot of emphasis on a borrower’s credit score, net worth, and commercial real estate experience, whereas CMBS financing is underwritten on the financial strength of the asset held as collateral.

Unlike banks, which generally keep loans on their balance sheets, CMBS lenders pool their loans together, creating commercial mortgage backed securities, and selling them to investors on the secondary market. Due to risk retention rules, CMBS lenders do have to keep 5% of each loan on their balance sheet. However, this does not generally change anything for the average borrower.

Unlike borrowers for commercial bank loans, CMBS borrowers will not continue to deal with the same lender that originated their loan during the remainder of its life; instead, they will have to work with a loan servicer, referred to as a master servicer. If a borrower defaults on their loan, they will have to work with another type of servicer, known as a special servicer.

The Benefits and Drawbacks of CMBS Loans:

The major advantages of CMBS loans are that they are available to a wide swath of borrowers, including those that might be excluded from traditional lenders due to poor credit, previous bankruptcies, or strict collateral/net worth requirements. Plus, CMBS loans are non-recourse, which means that even if a borrower defaults on their loan, the lender can’t go after their personal property in order to repay the debt. In addition, CMBS loans offer relatively high leverage, at up to 75% for most property types (and even 80% in some scenarios). CMBS loan rates are also incredibly competitive, and can often beat out comparable bank loan rates for similar borrowers. CMBS loans are also assumable, making it somewhat easier for a borrower to exit the property before the end of their loan term. Finally, CMBS loans permit cash-out refinancing, which is a fantastic benefit for businesses that want to extract equity out of their commercial properties in order to renovate them, or to get the funds to expand their core business.

The major downside of CMBS loans is the difficulty of getting out the loan early. Most, if not all CMBS loans have prepayment penalties, and while some permit yield maintenance (paying a percentage based fee to exit the loan), other CMBS loans require defeasance, which involves a borrower purchasing bonds in order to both repay their loan and provide the lender/investors with a suitable source of income to replace it. Defeasance can get expensive, especially if the lender/investors require that the borrower replace their loan with U.S. Treasury bonds, instead of less expensive agency bonds, like those from Fannie Mae or Freddie Mac. In addition, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, it should be noted that most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes. However, this is not necessarily a con, since many other commercial real estate loans require similar impounds/escrows.

In general, lenders look at two major metrics when deciding whether to approve a CMBS loan; DSCR and LTV. However, they also look at debt yield, a metric which is determined by taking the net operating income of a property and dividing it by the total loan amount. Additionally, lenders typically require a borrower to have a net worth of at least 25% of the entire loan amount, and a liquidity of at least 5% of the loan amount.

CMBS loans are primarily available for the financing of any income-producing commercial property, including multifamily assets, hospitality assets, office assets, retail assets, and industrial assets. While other property types may be eligible, they may be harder to classify.

The major downside of CMBS loans is the difficulty of getting out the loan early. Most, if not all CMBS loans have prepayment penalties, and while some permit yield maintenance (paying a percentage based fee to exit the loan), other CMBS loans require defeasance, which involves a borrower purchasing bonds in order to both repay their loan and provide the lender/investors with a suitable source of income to replace it. Defeasance can get expensive, especially if the lender/investors require that the borrower replace their loan with U.S. Treasury bonds, instead of less expensive agency bonds, like those from Fannie Mae or Freddie Mac.

In addition, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, it should be noted that most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes. However, this is not necessarily a con, since many other commercial real estate loans require similar impounds/escrows.

REITs are not typically part of the CMBS loan process. REITs are real estate investment trusts that directly hold property, while CMBS loans are commercial mortgage-backed securities that are derived from a pool of loans. CMBS loans are typically issued by conduit lenders, who pool the loans together and then issue the CMBS. Investors can then purchase the CMBS on the open market, similar to bonds. For investors who want to place funds in the commercial real estate market, while limiting risk, investing in a CMBS ETF can be an ideal choice. These ETFs are generally less risky than investing in REITs, and typically offer higher yields than bonds with a comparable risk profile.