CMBS Loans Explained
Conduit loans, also known as CMBS loans, are commercial real estate loans that are pooled together with similar commercial mortgages and sold on the secondary market. CMBS loans are known for their relaxed credit requirements, but are only available for income-generating properties, and cannot typically be used as land or construction loans.
On the secondary market, conduit loans are divided into tranches— different groups based on risk, return, and loan maturity. Risker loans with longer terms and higher interest rates will likely be sold to higher risk investors, like hedge funds, while lower risk investors, such as pension funds, are more likely to go with lower-risk tranches.
CMBS Loan Features, Rates, and Prepayment Penalties
In general, CMBS loans non-recourse, fixed-rate, and fully assumable, giving them a lot of benefits for potential borrowers. In addition, conduit loan interest rates are generally competitive, and are based on U.S. Treasury rates plus a margin, or spread. This spread is determined by a several factors, including property quality and condition, quality of management, quality of tenants, and property cash flow, as determined by debt service coverage ratio, or DSCR.
Unlike many commercial property loans, conduit loan borrowers will often have to pay defeasance in order to prepay their loan. Defeasance involves a borrower purchasing an equivalent number of substitute bonds, usually U.S. Treasury bonds, but sometimes Fannie Mae or Freddie Mac securities, in order to replace the income provided by their loan. Other CMBS loans allow yield maintenance, the payment of a specific percentage of the loan, as a prepayment penalty.