CMBS Primer: A Basic Guide to CMBS/Conduit Loans
CMBS loans, also referred to as conduit loans, are one of the most popular ways to finance commercial real estate in the United States. They are offered for almost all types of income-producing commercial properties, such as office buildings, shopping centers, apartment buildings, and hotels. When compared to other types of commercial property loans, CMBS loans have a variety of advantages and disadvantages. In this CMBS primer, we’ll discuss the differences between conduit loans and other types of commercial financing, and tell borrowers exactly what they need to know before deciding to take on CMBS debt.
- The Basics of CMBS Financing: What Potential Borrowers Should Know
- CMBS Loan Terms and Interest Rates
- CMBS vs. Bank Loans
- CMBS Multifamily Loans vs. Agency and HUD Multifamily Loans
- CMBS Deal Structuring and Flexibility
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The Basics of CMBS Financing: What Potential Borrowers Should Know
CMBS loans, also referred to as conduit loans, are one of the most popular ways to finance commercial real estate in the United States. They are offered for almost all types of income-producing commercial properties, such as office buildings, shopping centers, apartment buildings, and hotels. When compared to other types of commercial property loans, CMBS loans have a variety of advantages and disadvantages. In this CMBS primer, we’ll discuss the differences between conduit loans and other types of commercial financing, and tell borrowers exactly what they need to know before deciding to take on CMBS debt.
CMBS Loan Terms and Interest Rates
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.
CMBS vs. Bank Loans
For borrowers with sufficient cash, say, 25%, who want to purchase an income-producing property, a CMBS loan is often significantly easier to get approved for, and will usually offer rates very competitive with bank financing (if not substantially better). In many cases, banks will only offer 5-year loans for commercial properties, and will generally put a lot of emphasis on a borrower’s credit score, net worth, and commercial real estate experience. This is not the case for CMBS financing, where the property itself is the most important factor in the loan approval process.
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. This is not always ideal, as a special servicer will generally put the investor’s needs (and their interests) above the needs of the borrower.
CMBS Multifamily Loans vs. Agency and HUD Multifamily Loans
For multifamily borrowers, CMBS loans are also an effective alternative to Freddie Mac and Fannie Mae multifamily loans, especially in situations where borrowers do not have the best credit or the highest net worth. Fannie and Freddie (the “agencies”) are also particular about the fact that they usually want borrowers to have significant multifamily real estate experience. However, for those who can get them, agency multifamily loans can offer significant benefits, with interest rates even lower than CMBS, supplemental financing options, and even (in some cases) fully-amortizing financing. The same can be said of HUD multifamily loans, in particular, the HUD 223(f) program, which offers LTVs up to 85% for market-rate properties.
Like CMBS loans, both agency multifamily loans and HUD multifamily loans are securitized. However, in many cases, the servicing process for these loans is a little less onerous for borrowers. This is especially the case for agency loans, as many Fannie Mae and Freddie Mac lenders operate as seller/servicers, meaning that they also service the loans they issue to borrowers.
CMBS Deal Structuring and Flexibility
One of the major downsides to CMBS lending is the fact that lenders are often relatively inflexible when it comes to structuring loans. In general, this is because loans that differ from standardized CMBS requirements can make the securitization process a major challenge. In fact, many lenders will sometimes say that CMBS rules prevent them from making changes-- when really they do not. They will often say this in order to avoid needing to register an exemption during the CMBS process, as this could lead to headaches for them down the line.
Therefore, borrowers who are looking to make a CMBS transaction with certain alterations should be sure to read (or have a lawyer or advisor read) the exact rules and agreements under which that lender does business. Some lenders may be more flexible than others, so it can pay to make sure you’re working with a lender who will not have to stretch themselves in order to accommodate relatively minor requests.
CMBS Loan Assumption
One of the benefits of CMBS loans is the fact that they are generally fully assumable for a small fee. This makes it much easier for borrowers to get out of a loan early without paying a prepayment penalty. It can also make it easier for a borrower to sell a property, as the new owner/borrower will not have to go through the entire approval process, including paying expensive legal fees (though they will still need to be approved).
CMBS Advantages and Disadvantages
As we mentioned in the beginning of this guide, CMBS loans have both advantages and disadvantages for commercial real estate borrowers.
CMBS Advantages:
Easier qualification process than bank loans
High LTVs allowed (up to 80%)
Low interest rates
Loans are non-recourse
Loans are fully assumable (fee and certification often required)
Borrowers must interact with a non-lender servicer
Lack of structuring flexibility
Borrowers often need confirmation from a rating agency in order for another borrower to assume a CMBS loan
Legal fees can be expensive, often starting at $15,000
What is a CMBS loan?
A CMBS loan, also known as a conduit loan, is a type of real estate loan that’s secured by a first position mortgage on a commercial property. CMBS loans are typically offered by commercial banks, conduit lenders, or investment banks, and, once they are issued, they are packaged and sold to other investors. Due to that fact that banks do not hold CMBS loans on their balance sheets, they can offer these loans to borrowers at relatively low fixed interest rates, and can also offer borrowers relatively high leverage.
What are the benefits of a CMBS loan?
CMBS loans have several incredible upsides. First, these 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).
Perhaps most importantly, 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 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 types of properties are eligible for CMBS loans?
CMBS loans can be used for a variety of property types, including office, mixed-use, and multifamily properties. Office assets, such as traditional high-rises and low-rises, single-story office parks, medical office buildings, and mixed-use buildings (Class A and Class B only) are eligible for CMBS financing. Mixed-use properties, ranging from apartment properties with a few commercial tenants to larger complexes with living spaces and retail stores, restaurants, or entertainment businesses, are also eligible. Multifamily and apartment properties, including student housing, senior care facilities, and mixed-use properties, are also eligible for CMBS financing.
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What are the requirements for obtaining a CMBS loan?
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.
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. This is not always ideal, as a special servicer will generally put the investor’s needs (and their interests) above the needs of the borrower.
By and large, the most time consuming part of CMBS origination is the underwriting process, which is intended to determine whether a borrower presents a reasonable credit risk to a lender. A lender will require third-party reports, such as a full appraisal and Phase I Environmental Assessment, and will check into a borrower’s credit history, net worth, and commercial real estate experience. While borrower credit, net worth, and experience requirements are significantly less strict for conduit loans than for bank or agency loans (i.e. Fannie Mae and Freddie Mac), having good credit and some commercial real estate ownership/management experience certainly helps.
CMBS Disadvantages:
CMBS Provides a Great Opportunity, But Borrowers Need to Remain Aware
In conclusion, CMBS loans are a great opportunity for many kinds of commercial real estate investors— especially those who wish to acquire or recapitalize properties that simply aren’t suitable for bank financing. However, CMBS loans are more complex, and have slightly more risks than a typical commercial bank loan, especially if a borrower anticipates having trouble repaying their loan payments or believes they might need a more flexible loan structure. For these reasons, borrowers should be familiar with all the ins and outs of conduit loans before making a final decision.