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The Pros and Cons of CMBS Loans: A Guide
CMBS loans aren’t ideal for everyone, but they have some advantages other financing products don't. Learn more with our guide.
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, provided a property meets a lender's debt yield requirements. 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.
What are the advantages of CMBS loans?
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 disadvantages of CMBS loans?
The major disadvantages of CMBS loans include:
- Less autonomy in the operation of the property and limited flexibility to deviate from the terms of the loan documents.
- Difficulty in releasing collateral.
- Expensive to exit.
- Lock outs often prevent prepayment or up to two years.
- Reserves required.
- Secondary financing (i.e. mezzanine debt or preferred equity) not always allowed.
- 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.
- CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors.
- Most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes.
What types of properties are eligible for CMBS loans?
CMBS loans can be used for a variety of property types, including office properties, mixed-use properties, and apartment properties. Office properties eligible for CMBS financing include traditional high-rises and low-rises, single-story office parks, medical office buildings, and mixed-use buildings. Mixed-use properties eligible for CMBS financing range from apartment properties that contain a few units for commercial tenants, to much larger mixed-use complexes that combine living spaces with a variety of different retail stores, restaurants, or entertainment businesses. Learn more about CMBS financing here.
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.
To obtain a CMBS loan, lenders 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. Additionally, borrowers must be prepared to work with a loan servicer, referred to as a master servicer, and if a borrower defaults on their loan, they will have to work with another type of servicer, known as a special servicer.
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. The actual interest rate on your loan will generally be based on current U.S. Treasury swap rates, which often is lower for CMBS loans than for traditional commercial property mortgages.
According to Multifamily.loans, 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. Of course, CMBS loans are later securitized and sold to investors, so the spread also provides for the investors’ profits.
According to CMBS.loans, most CMBS loans use fixed interest rates. This benefits borrowers, but it also provides stable, projectable income for investors who have purchased the mortgage-backed securities.
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.