Conduit Financing: The Benefits and Risks for CRE Borrowers
While CMBS loans all but disappeared after the 2008 market crash, in the last 4-5 years, the CMBS market has been stronger than ever, with nearly $88 billion of loans issued in 2017, and $76 billion of loans issued in 2018. CMBS came roaring back for a variety of reasons, including the fact that they often provide the highest leverage loan a borrower can get for properties in secondary and tertiary markets. However, CMBS loans aren’t ideal for everyone— as they can provide a particularly poor loan servicing experience rife with significant prepayment penalties.
The Pros of CMBS/Conduit Loans
When it comes to financing a non-Class A commercial property, or financing a property owned by a borrower with a less-than-ideal financial history, CMBS loans can be an ideal choice. Since CMBS loans are generally asset-based, underwriters don’t delve too deeply into borrower financials, which can be highly beneficial for borrowers who may not have the greatest credit. In addition, CMBS loans are fully assumable, so if a borrower wants to sell their property, they can transfer the loan to the new buyer.
Most importantly, however, CMBS offers leverages up to 75%, with rates, on average, as low as 4.30% for many borrowers. Conduit loans are also typically fixed-rate, so a borrower won’t have to worry about rates fluctuating during the life of their loan.
The Cons of CMBS/Conduit Loans
In the beginning of this article, we mentioned that conduit loans may not provide a great servicing experience. This is because, in general, CMBS lenders don’t service these loans themselves; instead, they hire this out to a third-party servicer, who may not have the borrower’s best interests in mind. Plus, the fact that these loans are pooled, securitized, and sold on the secondary market means that most borrowers will be required to conduct either yield maintenance or defeasance in order to repay their loan.
In addition, because these loans are securitized, borrowers who have trouble repaying their loans are unlikely to get any form of forbearance or foreclosure/default prevention assistance. Instead, if the borrower cannot make their monthly payments, they will likely default on the loan relatively quickly.
CMBS Loans Compared to Other Types of CRE Financing
For multifamily properties, if a borrower can qualify for a Fannie Mae, Freddie Mac, or HUD/FHA multifamily loan, they are likely to get slightly better interest rates, along with (potentially) somewhat better servicing. They will also face slightly less onerous prepayment penalties, as well as enjoy somewhat higher leverage allowances, often between 80-85%, with up to 90% for affordable properties.
For a non-multifamily commercial property, life company loans also offer lower rates and superior servicing. Since life company lenders keep these loans on their books, a life company borrower can typically deal directly with their lender for the entire life of their loan.
However, all the types of multifamily loans above generally have much stricter borrowing requirements than CMBS, and typically look deep into a borrower’s financials. Plus, in the vast majority of cases, these loan types do not offer any form of cash-out, while certain CMBS transactions do.