CMBS Loans vs. Portfolio Loans: What's the Difference?
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.
Lenders Sell CMBS Loans, While Keeping Portfolio Loans on Their Balance Sheets
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.
Recourse Provisions and Prepayment
One of the biggest differences between CMBS loans and portfolio loans is that CMBS loans are typically non-recourse, while portfolio loans are not. In general, CMBS borrowers can only face a loan’s recourse provision if they engage in certain bad acts, such as fraud, or material misrepresentation of their financial assets. Also, most portfolio loans permit a borrower to use yield maintenance to prepay their loan, while many CMBS loans require borrowers to conduct defeasance to prepay. Defeasance, which involves the purchase of substitute bonds in order to replace the loan’s collateral and provide substitute income for the lender, is typically a more expensive and time consuming process.
Borrower Eligibility and Loan Requirements
Since CMBS lenders don’t keep conduit loans on their balance sheets, in general, they can afford to be slightly more liberal when it comes to credit score and net worth requirements. While conduit loans typically require the borrower to have some amount of outside collateral, the main collateral for the loan is the property itself. In contrast, portfolio loans often have stricter credit and net worth requirements, which could put them out of reach of certain commercial real estate borrowers.
Loan Defaults, Collateral Substitutions, and Debt Workouts
In general, portfolio lenders have a much closer relationship with borrowers, and this means that they can often provide personalized assistance and solutions in the case of a loan default. In contrast, CMBS lenders typically have to send any defaulted loans to a special servicer, who must comply with the CMBS's Pooling and Servicing Agreement (PSA), as well as the rules of the Real Estate Mortgage Investment Conduit (REMIC), which is an special purpose entity (SPE) used specifically to pool conduit loans. Due to this, CMBS lenders and special servicers cannot typically provide any form of debt workout, or any preemptive loan modifactions that a portfolio lender might be able to make.
In contrast, it’s much easier for portfolio lenders and servicers to accept substitute or additional collateral, take an equity position, capitalize past due interest, or lend additional money as a way to prevent or solve a loan default. Because CMBS borrowers are required to form a special purpose entity, or SPE, that is bankruptcy remote, this limits a conduit loan borrower’s ability to file for bankruptcy, and since these entities are single-purpose, it also prevents the borrower from substituting or adding collateral to repay the loan.
In addition, CMBS loans often have other requirements, such as providing regular financial reports to a servicer, as well as a property management control provision, which states that a lender can replace property management should they feel this is appropriate.
Related Questions
What are the advantages of CMBS loans over portfolio loans?
CMBS loans have several advantages over portfolio loans. CMBS loans are typically non-recourse, meaning that borrowers can only face a loan’s recourse provision if they engage in certain bad acts, such as fraud, or material misrepresentation of their financial assets. In addition, CMBS borrowers can use defeasance to prepay their loan, while many portfolio loans require borrowers to use yield maintenance, which is typically a more expensive and time consuming process. Lastly, CMBS lenders don’t keep conduit loans on their balance sheets, so they can afford to be slightly more liberal when it comes to credit score and net worth requirements.
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What are the disadvantages of CMBS loans compared to portfolio loans?
The main disadvantage of CMBS loans compared to portfolio loans is that CMBS loans are typically non-recourse, while portfolio loans are not. This means that CMBS borrowers can only face a loan’s recourse provision if they engage in certain bad acts, such as fraud, or material misrepresentation of their financial assets. Also, most portfolio loans permit a borrower to use yield maintenance to prepay their loan, while many CMBS loans require borrowers to conduct defeasance to prepay, which is typically a more expensive and time consuming process.
Since CMBS lenders don’t keep conduit loans on their balance sheets, in general, they can afford to be slightly more liberal when it comes to credit score and net worth requirements. However, portfolio lenders often have stricter credit and net worth requirements, which could put them out of reach of certain commercial real estate borrowers.
In general, portfolio lenders have a much closer relationship with borrowers, and this means that they can often provide personalized assistance and solutions in the case of a loan default. In contrast, CMBS lenders typically have to send any defaulted loans to a special servicer, who must comply with the CMBS's Pooling and Servicing Agreement (PSA), as well as the rules of the Real Estate Mortgage Investment Conduit (REMIC), which is an special purpose entity (SPE) used specifically to pool conduit loans. Due to this, CMBS lenders and special servicers cannot typically provide any form of debt workout, or any preemptive loan modifactions that a portfolio lender might be able to make.
In addition, CMBS loans often have other requirements, such as providing regular financial reports to a servicer, as well as a property management control provision, which states that a lender can replace property management should they feel this is appropriate.
What are the eligibility requirements for CMBS loans?
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. This helps determine how long it would take a lender to recoup their losses if they had to foreclose on the property. And, while it’s true that CMBS loans are mostly income based, lenders still 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.
In order for investors to work around the fact that CMBS financing is generally not available for owner-occupied properties, a real estate firm or similar entity would have to take out the CMBS loan on the property, and then lease it to the owners of the hospital or healthcare firm.
When it comes to longer-term, fixed-rate financing for stable retail properties, CMBS lenders generally prefer retail assets with strong, long-term anchor tenants as well as properties managed by experienced organizations.
What are the typical interest rates for CMBS loans?
Interest rates for CMBS loans vary by the day but usually stay within a tight range for most borrowers, with exceptions for particularly desirable or particularly risky properties. CMBS loan rates are generally based on the swap rate, plus a margin, also known as a spread, which compensates a lender for their risk and provides for their profits. The actual interest rate on your loan will generally be based on current U.S. Treasury swap rates. This often is lower for CMBS loans than for traditional commercial property mortgages.
CMBS loans are typically fixed-rate, though floating-rate CMBS financing does exist. Conduit loans commonly begin at $2 million, though some lenders will go as low as $1 million.
What are the typical loan terms for CMBS loans?
CMBS loans are generally offered in 5, 7, or 10-year terms, with 15-year terms occasionally being offered in exceptional circumstances. 25-30 year amortizations are generally used, with partial and full term interest-only options often available. Conduit financing generally allows LTVs up to 75%, but 80% may be allowed in certain cases, with LTVs even higher if the senior conduit loan is combined with mezzanine debt. CMBS loans are typically fixed-rate, though floating-rate CMBS financing does exist. Conduit loans commonly begin at $2 million, though some lenders will go as low as $1 million. On the other end of the spectrum, the largest CMBS loans can be more than $1 billion.