Commercial Mortgage Backed Securities
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. CMBS stands for “commercial mortgage backed security,” as these loans are pooled into securities and sold on the secondary market to investors. CMBS financing is often ideal for projects that are not a good fit for agency lenders like Fannie Mae or Freddie Mac.
Since CMBS is more asset based, lenders may be more likely to approve borrowers with credit or legal issues, such as a recent bankruptcy. These loans 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.
CMBS Loans Offer Significant Benefits for Multifamily Investors
CMBS loans are available for properties in most commercial asset classes, including office buildings, retail centers, apartment buildings, hotels, industrial properties, and more. However, conduit lenders may offer slightly less leverage for riskier property types, such as hotels. Despite that, unlike Fannie Mae, Freddie Mac, and HUD multifamily loans, CMBS multifamily loans don’t have any commercial space restrictions, so they can be utilized for mixed-use properties.
While the fact that CMBS loans are fully non-recourse significantly reduces risk for borrowers, CMBS debt still comes with bad boy carve outs, which make a loan fully recourse if a borrower commits certain “bad acts”, such as intentionally declaring bankruptcy or committing fraud.
General CMBS Requirements for Multifamily Financing
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.
Prepayment Penalties for Conduit Loans
Conduit loans typically require one of two types of prepayment penalties; defeasance or yield maintenance. Defeasance is the process of actually replacing the loan’s collateral with equivalent securities, in most cases, treasury bonds. While it depends on prevailing interest rates and exact terms of a borrower’s loan agreement, defeasance can often be quite expensive for borrowers.
The other prepayment option is yield maintenance, which reimburses investors for the interest they lose as a result of a borrower paying off a loan early. Usually this involves paying the both the remaining collateral of the loan, and paying the gap between with interest rate and the current U.S. Treasury rate. If interest rates are falling, yield maintenance is more expensive for borrowers, while if interest rates are climbing, it’s significantly less expensive. However, yield maintenance formulas can be somewhat complex, and typically include a floor of 1%, meaning that even if the interest rate is now the same (or even less) than the U.S. Treasury rate, borrowers will have to pay a small fee.
Loan Servicing for CMBS Borrowers
As a final note, potential CMBS borrowers should understand that, unlike bank loans, you will not be dealing directly with your lender after your loan has been securitized and sold to investors. Instead, you will work with a master servicer, a company which specifically works to administer conduit loans. In addition to collecting payments, a master servicer (or a company they have contracted) is responsible for inspecting the property and taking care of other administrative functions.
If you default on your loan, it will typically be sent to a special servicer, who may be able to adjust the terms of your debt. This could include deferring or forgiving interest or fees, or allowing the substitution of collateral. However, the special servicer works for the investors, not the borrower, so if they believe that foreclosing on the property will increase investor profits, they will almost certainly do so. In other cases, they may assist with the loan assumption process, in which another borrower would take on the CMBS debt. In general, banks and life companies are significantly more flexible when it comes to modifying loan terms when compared to CMBS.
Mezzanine Debt and Preferred Equity
While CMBS typically offers leverage up to 75% for qualified borrowers, some investors may wish to increase their leverage even further by adding a mezzanine loan or preferred equity to their capital stack, which can greatly increase their IRR. Some conduit lenders allow this, while others do not. While the CMBS lender will still be the first to be repaid should the borrower default, mezzanine debt can add to a borrower’s monthly debt service and could make it harder for them to repay their primary loan. Either way, the addition of a second-position loan on top of CMBS senior debt often requires creative structuring, additional legal fees, and the use of an intercreditor agreement between the two lenders.
Sample CMBS Terms For Apartment and Commercial Property Loans
Size: $2 million and up
Term: 5, 7, and 10 year fixed
Interest Rates: Starting at 200bps over relative swap rate
Amortization: 25- 30 years
Maximum LTV: 75%
Minimum DSCR: 1.25
Minimum Debt Yield: 8.7%
Reserves: Taxes, insurance, replacement reserve and leasing costs
Prepayment: Defeasance or yield maintenance
Property Types: Multifamily
Attractive fixed rates for long term loans.
Can go up to 75% LTV.
Wide range of loan sizes.
Will consider non-Class “A” assets.
Less scrutiny for borrowers.
Provides cash out refinancing.
Loans are fully assumable.
Can be combined with mezzanine debt or preferred equity in many scenarios.
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.
Secondary financing (i.e. mezzanine debt or preferred equity) not always allowed.