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Commercial mortgage-backed securities (CMBS loans) are some of the most common ways to finance U.S.-based commercial real estate projects. The loans are widely available for nearly all types of commercial properties, and they have some notable advantages over other kinds of commercial property loans.

CMBS loans are also referred to as "conduit loans" because of how they're resold as securities. The loans are frequently packaged together and resold to investors as fixed-income investments. Thus, the loans are essentially resold as bonds and provide commercial property owners with indirect access to bond investors' capital.

CMBS Loan Highlights

Eligible Properties: Multifamily, Office, Warehouse/Industrial, Mixed Use, Retail, Medical/Healthcare, Self Storage

Loan amount range: Minimum $2,000,000

Interest Rate: Fixed rate throughout term and priced over corresponding swap rate.

Loan Term: 5, 7, and 10-year fixed

Amortization: 25-30 year amortization with up to 10 years of interest-only available in select instances.

Maximum LTV: 75%

Minimum DSCR: 1.20-1.25x

Minimum Debt Yield: 7-8%

Recourse: Non-recourse except industry-standard "bad boy act" carve-outs.

Prepayment: Typical 2 to 3 year lockout, defeasance or yield maintenance thereafter.

Reserves: Taxes, Insurance, Replacement Reserves, Tenant Improvements and Leasing Commissions typically required.

Advantages of CMBS Loans

CMBS loans' features offer several advantages that make them an attractive financing option in many situations:

  • Conduit loans usually come with fixed interest rates, and the rates are commonly lower than what's available through conventional mortgages. Interest rates are typically based on the current U.S. Treasury rate with a margin added on.
  • Conduit loans are both non-recourse and assumable. The former feature helps protect individuals, while the latter makes it possible to sell a commercial property without refining the loan terms.
  • Conduit loans are available in a wide range of amounts, and they aren't restricted to the terms that commercial mortgages which are offered through major agencies must meet.

Disadvantages of CMBS Loans

The advantages that CMBS loans offer make them well-suited to many properties and projects, but property owners should be aware of two disadvantages:

  • Although conduit loans aren't limited to the restrictions of major agencies, they still must comply with tax laws that allow the loans to be resold as securities. This restricts what variables borrowers can negotiate in the loan terms.
  • Conduit loans' prepayment penalties can carry more risk than the prepayment penalties of conventional mortgages. Whereas a conventional mortgage's prepayment penalty is normally calculated as a percentage of the lost interest, a conduit's loan is often tied to the Treasury yield. If Treasury bonds go down substantially, this can result in substantial additional prepayment costs.

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What Are CMBS Loans?

CMBS loans are underwritten as first-position mortgages for commercial real estate properties. As a first-position mortgage, this kind of loan is the primary -- and usually the initial loan -- on a commercial property. Should a property owner be unable to pay on their loans, a first-position loan has the first lien right against the owner's defaulted property.

One of the main characteristics of CMBS financing is that they re packaged with other like loans and resold as "commercial mortgage-backed securities" (which is what "CMBS" stands for). Investors who purchase these bonds are typically looking for a fixed-income investment with limited risk exposure.

What Commercial Properties Are CMBS Loans Well Suited For?

CMBS loans primarly are available for apartment buildings, office buildings, shopping centers, hotels, mixed-use complexes and industrail commercial properties. The loans are often used when a conventional commercial mortgage isn't available or preferable. For example, apartment building owners may use a CMBS to finance properties that don't qualify for a Fannie Mae or Freddie Mac mortgage.

What Terms Do CMBS Loans Offer?

Because CMBS loans aren't regulated by a federal or state agency, the loans offer flexible terms that can be adjusted to suit many different commercial properties. Most of these loans are written for 5, 7, 10 years, and based on 25- or 30-year amortization schedules. Loan-to-value (LTV) ratios of up to 75 percent are permitted, and some may allow even higher LTV ratios if a CMBS loan is combined with mezzanine debt. Most loans have fixed rates, although variable rate conduit loans can be found.

With regard to the amount borrowed, CMBS loans most often have balances starting at $3 million. Loans for as little as $1 million are offered in some cases, though. On the other end of the spectrum, these loans can be written for $1 billion or more.

CMBS Loan Features:

CMBS loans come with many features that are attractive to commercial property owners, which is largely why these loans are so commonly used. Below are some of the more notable features that these loans have.

Non-Recourse: CMBS loans are non-recourse loans, which generally means that borrowers aren't personally liable for repayment of the loan. Only cash flows from the financed property and its value can be seized in the event of default or foreclosure.

In a few exceptions, CMBS loan terms do allow lenders and investors to hold borrowers personally liable if the borrowers act in a way that harms the property or investment. For example, borrowers may be personally liable if they commit loan fraud or take collusive action which results in bankruptcy. These exceptions are colloquially called the "bad-boy carve outs."

Prepayment Penalty: Because CMBS loans are bought and sold as fixed-income investments, they typically come with prepayment penalties. These penalties may be structured in two ways.

A yield maintenance prepayment penalty is assessed if the loan is paid in full and prior to the open period. The purpose of yield maintenance is to let investors maintain their expected returns on the investment in the secondary market.

A defeasance penalty involves the substitution of a property with U.S. Treasury bonds usually used as collateral. With defeasance, the substitute collateral provides the funds necessary to cover the loan payments.

Loan Assumption: Most CMBS loans are assumable loans, which is helpful if a financed property is sold. When the borrower sells the property to a purchaser, the purchaser assumes the obligations of the original loan and the initial borrower is released from the loan.

Are CMBS Loans Rated?

Several rating agencies provide credit ratings for CMBS loans. The majority of ratings run from AAA through BBB-, along with an unrated class that's the lowest. Major CMBS rating agencies within the United States include Morningstar, S&P, Kroll, Fitch and Moody's.

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