CMBS vs. Life Company Loans
When it comes to commercial real estate lending, there are typically two major kinds of loans, CMBS loans, also known as conduit loans, and portfolio loans. Conduit loans and portfolio loans have several key differences— and borrowers should be aware of them before deciding which type of commercial real estate financing best fits their individual needs.
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Lenders Sell CMBS Loans, While Life Companies Keep Loans on Their Balance Sheets
When it comes to getting long term, fixed rate loans for commercial real estate, CMBS loans and life company loans are two of the most common options available to borrowers. While CMBS loans are issued by lenders, pooled into securities, and then sold on the secondary market, life insurance companies typically keep loans on their books. While life companies typically lend much more conservatively than conduit lenders, the fact that they keep loans on their balance sheets gives them significantly more flexibility when it comes loan defaults, debt workouts, and other issues of importance to borrowers.
Recourse and Loan Amortization
In general, both CMBS and Life Company Loans are non-recourse with standard “bad boy” carveouts for fraud, financial misrepresentation, and other bad acts. However, some life company loans have “burn-off” recourse provisions that expire after a few years, which can reduce risk for life insurance companies in the early stages of a loan. In addition, while the vast majority of CMBS loans are partially amortizing with 5,7, or 10 year terms, many life company loans are fully amortizing with up to 30 year terms, which means that borrowers won’t have to worry about making a hefty balloon payment at loan maturity.
Borrower Eligibility and Loan Application
In comparison to life company loans, conduit loans are typically much easier to apply for and get approved for. Since life companies generally prioritize reducing risk at all costs, it’s incredibly difficult to get a life company loan if you’re not purchasing or refinancing premium real estate. Life companies also usually look for borrowers who have excellent credit scores and high net worth. In contrast, CMBS lenders are not as concerned with these factors.
Leverage and Prepayment
In most cases, life company loans have stricter LTV requirements than conduit loans for comparable properties. While most CMBS lenders permit up to 75% LTV, life companies are slightly more conservative, with average maximum LTV allowances generally ranging between 65% and 70%, with 75% LTV allowed for certain high-quality multifamily properties and commercial properties with strong anchor tenants. When it comes to prepayment, CMBS and life company loans are relatively similar; both generally offer either defeasance or prepayment premiums, or the borrower’s choice of the two. In the case of CMBS loans, prepayment premiums are structured as yield maintenance, while for life company loans, prepayment premiums are generally structured as step-downs or soft-step downs.
Earn-outs, Forwards, and Rate Locks
In addition to having more flexibility when it comes to loan defaults and modifications, life companies can also offer other benefits to borrowers, such as permitting earn-outs, which stipulate that a lender will increase the borrower’s loan amount if a property hits specific financial performance metrics. Plus, life company borrowers can sometimes get forward commitments from life companies, which are relatively uncommon in the CMBS lending space. In many cases, life company loan borrowers can also get a rate lock at application, while CMBS loan borrowers usually have to wait until funding. However, some CMBS lenders do offer 30-day rate locks, often for a small fee.
Related Questions
What are the differences between CMBS and life company loans?
CMBS loans are typically much easier to apply for and get approved for than life company loans. CMBS lenders are not as concerned with credit scores and high net worth as life companies, who prioritize reducing risk at all costs. CMBS lenders offer benefits such as interest-only periods and full, interest-only loans, while life company loans offer significantly lower rates and better loan servicing. Life company loans have longer terms, up to 25-year, fully amortizing loans, but have stringent lending standards and don't offer as much leverage as CMBS lenders, with leverage maxing out at 70%.
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What are the advantages of CMBS loans?
CMBS loans have several advantages, including flexible underwriting guidelines, fixed-rate financing, full assumability, and the potential for lenders and bondholders to achieve a higher yield on investments. Investors can also choose which tranche to purchase, allowing them to work within their own risk profiles. Additionally, CMBS loans 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). Finally, CMBS loan rates are 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, it should definitely be mentioned that 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.
What are the advantages of life company loans?
Life company loans offer several advantages, including:
- Will consider loan modifications or special requests (i.e. secondary financing) during the loan term.
- Early rate lock (up to 90 days prior to closing).
- Non-recourse.
In addition, life company loans can offer significantly lower rates than CMBS, and, unlike CMBS loans, offer an ideal servicing experience for borrowers. Since life companies keep these loans on their books, a borrower can interface directly with their lender to discuss any issues or concerns. Also, unlike CMBS loans, life company loan rates are often fixed during the application process, so a borrower will not have to worry about rates swinging wildly upward before their closing. Life company loans offer far longer terms than CMBS— with many life companies offering up to 25-year, fully amortizing loans.
What are the risks associated with CMBS loans?
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.
What are the risks associated with life company loans?
Life company loans have notoriously stringent lending standards; most properties must consist of Class A commercial real estate in a major MSA— and, unlike conduit lenders, life companies will typically look deep into borrower financials. In addition, life companies don’t offer nearly as much leverage as CMBS lenders, with leverage maxing out at 70%, and many companies only offering 50-55% leverage. Source
In general, both CMBS and Life Company Loans are non-recourse with standard “bad boy” carveouts for fraud, financial misrepresentation, and other bad acts. However, some life company loans have “burn-off” recourse provisions that expire after a few years, which can reduce risk for life insurance companies in the early stages of a loan. Source