CMBS LOANS

What Are CMBS Loans?

CMBS loans have become a very popular source of capital for commercial real estate investors looking for non-recourse financing. CMBS stands for commercial mortgage backed securities and is often referred to as a conduit loan. This type of loan plays an intricate role when it comes to commercial real estate financing. CMBS loans are secured by a first-position mortgage on a commercial property that is generally cash-flowing and stabilized.

Many property types can qualify for a CMBS loan, some of which include: apartment buildings, shopping centers, office, hotel, industrial and self storage properties.  Our CMBS financing experts can also finance warehouses, mobile home parks, student housing, marinas and parking garages.

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CMBS Loan Rates

Conduit loan rates are generally based on U.S. Treasury or Swap rate, plus a specific margin, otherwise known as spread. So how do lenders determine CMBS loans spreads? They are determined by underwriting various underlying factors that either increase or decrease the risk profile of the loan. Some of these factors include:

 

• Loan-to-Value (LTV) – CMBS lenders usually max out at 75% LTV. Lower LTV’s can produce lower spreads, therefore reducing the overall interest rate.
• Property Location – Since there is a direct correlation between loan spreads and risk, properties in stronger markets will benefit from reduced spreads that yield lower rates.
• Property Type – Generally speaking, riskier asset classes such as hotels and special purpose properties will warrant wider spreads. Multifamily, industrial, office, retail and self storage properties will command tighter spreads which result in lower rates.
• Tenant Roster – A diversifed tenant roster for commercial properties can be beneficial when compared to a single-tenant asset, which creates binary risk for a lender. A tenant’s credit rating can play a role here as well – as tenants with strong balance sheets and a higher credit rating are less likely to default and are more desirable to CMBS lenders.
• DSCR –  Conduit lenders typically  require a minimum debt service coverage ratio (DSCR) of 1.25x for most property types. Hotels are usually underwritten to a minimum DSCR of 1.40x. Naturally, the higher the DSCR the lower the risk. Same applies for an underwritten minimum Debt Yield, which is more commonly used when sizing a loan.
• Sponsorship Experience – CMBS loans are almost always non-recourse, with standard lender “bad-boy” carveouts. Having said that, CMBS lenders compete harder for borrowers with experience in leasing, property management and general ownership.  Lenders will reduce spreads, offer lower debt-yield requirements and improved overall deal terms to beat out the competition to secure such relationships.

CMBS Loans Explained

After the loan is closed and funded, the issuing conduit lender will look to package and sell the loan into a pool via a process called the “securitization”. During the securitization, hundreds of similar loans varying in loan size, interest rate and property type are pooled together and sold as bonds. One thing to keep in mind here is that conduit lenders do not look to have the loan on their balance sheet once a loan is made.

CMBS investors, also known as bond holders, have the ability to invest in various geographic location, property types and the credit rating, assessed by credit rating agencies prioer to closing. There are several different tranches from which investors choose to invest their capital. Each tranche represents a specific level of risk and rate of return with that associated risk.

CMBS Lenders

The largest CMBS lenders account for two-thirds of the loan origination in this space. 

Due Diligence Overview

The due diligence process for a CMBS loan is very similar to one of a balance sheet lenders such as credit unions and life company lenders. Below is a comprehensive overview of the diligence requirements.

(1) FIRREA-compliant appraisal with respect to the Property prepared by a firm selected by Lender.

(2) Phase I environmental survey and, if deemed necessary or appropriate by Lender, Phase II surveys of the Property, from a firm selected by Lender.

(3) Seismic Study, if deemed necessary or appropriate by Lender, of the Property, from a firm selected approved by Lender.

(4) Structural engineering report from a firm selected by Lender. Also known as Property Condition Report (PCA).

(5) Historical and current financial statements, operating statements, budgets, rent rolls and other information related to the financial condition of Borrower, Sponsor, their respective principals and the Property.

(6) Survey of the Property.

(7) Certificate of occupancy for the Property and zoning report prepared by a firm selected by Lender evidencing compliance with laws applicable to the Property.

(8) Copies of all leases and material contracts for the Property and appropriate estoppels relating thereto.

(9) Evidence that all utility services required for the Property are available and that the Property is subject to a separate tax assessment.

(10) Opinions of counsel and local counsel to Borrower and Sponsor in form and substance reasonably satisfactory to Lender.

(11) Organizational documents and evidence of authorization for the transaction of Borrower, Manager and such other entities as may be required by Lender.

(12) Such references, resumes and credit, litigation, tax, lien, judgment and other reports (including “Lexis/Nexis” reports) regarding Sponsor, Borrower and their principals as Lender may request (with such reports to be obtained by Lender, at its option).

Pros and Cons of CMBS  Loans

Like many other commercial real estate loan types, CMBS loans have advantages as well as some disadvantages that borrowers need to know about.

Pros:

The many benefits of CMBS loans is that they offer borrowers an opportunity to secure highly competitive non-recourse financing at higher leverage (LTV) than what some local banks or life insurance companies may allow. Conduit lenders  can offer up to 75% LTV for a term of 5, 7 or 10 years.

Another upside is the longer amortization period, which can go up to 30 years, providing borrowers better cash-flow. CMBS lenders can also lend in secondary and tertiary markets, an area life company lenders generally avoid. Borrowers often seek out conduit financing when they find a need to cash-out equity above their cost basis.

Conduit lenders can also offer interest-only financing for a part or full term of the loan. CMBS loans are assumable. This allows the current owner to sell the property to a perspective buyer who subsequently assumes the ownership position and the terms of the existing loan. This can benefit commercial real estate investors who are in a 1031 Exchange during a soft lending climate.

Last but not least, conduit lenders offer flexible underwriting guidelines, allowing novice commercial real estate investors to be financed creatively where a local savings bank may have been reluctant to lend.

Cons:

There are several aspects that make CMBS financing less attractive to commercial real estate investors. The lack of prepayment flexibility is usually at the forefront. Although some CMBS loans have Yield Maintenance as a prepayment penalty, the majority of these loans require Defeasance, which involves the borrower purchasing bonds in order to repay the bond holders with same revenue stream for the duration of the loan term. The collateral is usually replaced by U.S. Treasury bonds.

Supplemental or secondary financing is generally prohibited as increased leverage may pose additional risk to bond investors.

 

CMBS General Guidelines

CMBS interest rates are competitive and the loan is non-recourse, with standard “bad-boy” carve-outs. Interest rates are often fixed for 10-years, however, 5 and 7-year term loans are also available.

CMBS loans often come with more stringent prepayment provisions such as Defeasance or Yield Maintenance to protect the guaranteed yield of bond investors.