What is a CMBS Loan? Uncovering Hidden Risks and Benefits
CMBS loans, which are also referred to as conduit loans, are a type of real estate loan that’s secured by a first position mortgage on a commercial property.
What are CMBS Loans for Commercial Properties?
CMBS loans, which are also referred to as conduit loans, are 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 Common Features of CMBS Loans?
In addition to generally having fixed-interest rates, CMBS loans typically have terms of 5-10 years, with amortizations of between 25 and 30 years. Plus, CMBS loans are usually non-recourse and fully assumable. This means that, in most cases, a lender cannot go after a borrower’s personal property in the case of a loan default, and, that the borrower can pass on the CMBS loan to a new borrower should they want to sell their property.
What Borrowers are Eligible for Conduit Loans?
In general, lenders look at three major factors, DSCR, Cap Rate and LTV, when deciding if a borrower is eligible for a conduit loan. LTV, or loan-to-value ratio, is determined by dividing the loan amount by the appraised value of the commercial property, while DSCR is determined by the net operating income by the total debt service of the property. Most borrowers will accept properties with a maximum LTV of 75% and a DSCR of 1.25 to 1.35x. Lenders also look at a property’s debt yield, which can be determined by taking a property’s net operating income, dividing it by the loan amount, and multiplying it by 100. CMBS lenders typically prefer properties with a debt yield of 7% or more.
What is a CMBS loan and how does it work?
A CMBS loan stands for commercial mortgage-backed securities, and this refers to commercial mortgage loans that are pooled into securities and sold on the secondary market to investors. CMBS loans, also known as conduit loans, are non-recourse and offer low interest rates and relatively high leverage, with LTVs typically going up to 75% for eligible properties.
When a conduit lender issues a CMBS loan, they will pool it in with a variety of other loans in order to create a commercial mortgage-backed security (CMBS). These CMBS loans are similar to bonds, in the sense that they are traded on the open market. From an investing standpoint, CMBSs are often compared to RMBSs (residential mortgage-backed securities), which are securities based on residential mortgage loans.
CMBS financing is often ideal for projects that are not a good fit for agency lenders like Fannie Mae or Freddie Mac. Since CMBS underwriting is more asset focused, lenders are more flexible for borrowers with credit or legal issues, such as a recent bankruptcy. These loans are also great for when a situation requires a faster closing process with less red tape and more focus on the property income than the borrower or the curb appeal of the multifamily project.
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 types of commercial real estate properties are eligible for a CMBS loan?
CMBS loans can be used to finance a variety of commercial real estate properties, including retail, office, and mixed-use properties. Retail properties are generally preferred by CMBS lenders, as they tend to have strong, long-term anchor tenants and are managed by experienced organizations. Office assets are also popular in the CMBS loan market, and can be used for the acquisition, cash-out, or rate and term refinancing of Class A and Class B office properties. Mixed-use properties have also become increasingly popular in recent years, and CMBS loans can be used to finance a wide selection of these properties, ranging from small apartment complexes with a few commercial tenants, to larger mixed-use complexes.
What are the requirements for 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.
The general terms for a CMBS loan in 2022 are:
Minimum Loan Loan Term Interest Rates Amortization Leverage DSCR Recourse $2 million Five-, seven-, or 10-year fixed-rate loans Starting at 200 bps above relative Treasury 30 years 75% to 80% maximum LTV 1.25x minimum DSCR Non-recourse (with standard carve-outs)
What are the risks associated with a CMBS loan?
The major risks associated with a CMBS loan include difficulty getting out of the loan early, as most 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.