Commercial Mortgage-Backed Securities (CMBS) Loans
CMBS Loan Highlights
Advantages of CMBS Loans
CMBS loans' features offer several advantages that make them an attractive financing option in many situations:
- Fixed interest rates: Usually these are fixed 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.
- 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.
- Loan Size: 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:
- Tax Laws: 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.
- Prepayment Penalties: Carries 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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CMBS Loans FAQ’s
Commercial mortgage-backed securities otherwise referred to as CMBS loans, CMBS mortgages, or Conduit Loans, these are fixed-income investments held up by commercial real estate loans (as collateral).
The collateral loans in question are typically for commercial properties such as residential apartment buildings, malls, office spaces, hotels, and even factories. These loan options are useful for both commercial lenders and real estate investors because they provide liquidity, or, a high volume of cash activity.
One of the main characteristics of CMBS financing products is that they are 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.
Think of CMBS as something that facilitates the purchase of commodities. The commodities in question—land, acreage, property, etc.—can be bought as raw material and turned into a greater material to be sold for a profit. Or, they can be sold as-is to a higher bidder, which also yields a profit. The people that are making a profit are typically real estate investors or investor groups, commercial lenders, or syndicates of a commercial bank.
How CMBS Loans Work
CMBS loans are secured by a first-position mortgage. A first-position mortgage counts as the first lien, or first in line to have their debts paid. These types of loans are created in a group format that is essentially packaged and sold as a secured series of bonds. Each series bond is organized as a tranche, or, a bundle of “similar risks and rewards.”
For those who are issued lowest-risk CMBS, principal and interest payments are received first. The higher-risk CMBS are the ones who end up at a loss if their borrower defaults on payments. The risk rating issued is up to the lender’s discretion, taking into account the investment base, potential for earning, and risk capacity of the borrower in question.
CMBS loans are typically originated at a fixed interest rates, which may (or may not) include an introductory interest-only payment period. The interest rates are typically based on the treasury swap rate plus a spread (lender’s profit). See today's commercial mortgage rates for up-to-date information.
The amortization schedule for CMBS loans usually spans from 25 to 30 years, with a balloon payment towards the end of the loan. These loans are specifically meant for commercial real estate. Of course, unlike their correlating residential loans (RMBS loans), CMBS loans contain more risk because of the operating businesses located with each property.
Commercial Mortgage-Backed Securities are highly structured to ensure the certainty of cash flows passed through to the bondholders. Despite the fact that CMBS loans are not standardized like RMBS loans, having fixed terms reduces prepayment and default risks.
The Different Types of CMBS
As mentioned above, Commercial Mortgage-Backed Securities are classified by their tranche. Tranches are organized by level of credit risk, which ranges from the lowest to the highest risk.
- The lower-risk CMBS tranches are classified as “Senior,” which designates a higher quality credit rating.
- The higher risk tranches, which are of the lowest payment, are referred to as “Junior” bonds.
The Senior tranches receive principal and interest payments first, whereas the Junior tranches pay higher coupons in exchange for being the last to receive payments and first to absorb losses. Additionally, the tranches that absorb more risk also absorb more of the potential losses that may occur.
Organizing a CMBS capital structure into these classifications allows for a securitization process. Having this kind of structure is important for CMBS lenders and investors because it allows investors access to higher yields in commercial real estate investment compared to traditional government bonds. It also allows banks to recycle capital while generating a profit through arbitrage.
Structures and Risks of CMBS Loans
To describe the characteristics and risks of Commercial-Backed Mortgage Securities, it is best to break down loan features and requirements. Here is what is involved in structuring a CMBS loan:
Amortization and Term Length
A typical amortization schedule ranges from 25 to 30 years. Term lengths depend on many factors including cash flow analysis, credit risk profiles, risk profiles, and the lender’s discretion. Term lengths end with a balloon payment at maturity which is typically paid by either refinancing the existing loan or with the proceeds from selling the property.
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 "bad-boy carve outs."
CMBS loans include one to three different prepayment penalties—defeasance, yield maintenance, or a step-down/fixed schedule. Prepayment penalties exist to incentivize the borrower to stay with the loan for the entire term so the bondholders can receive their principal and interest payments as scheduled. CMBS loans can differ from other types of loans because they carry prepayment penalties for almost the entire term.
Defeasance occurs when a commercial real estate mortgage is removed from the CMBS trust and replaced with government bonds that produce identical cash flows. This provides bondholders with a stronger risk-adjusted investment profile.
Yield maintenance is when CMBS loan principal and interest is repaid in a lump sum, which is good for both parties. The bondholder will receive the same yield as if the borrower had made all of the scheduled loan payments.
A Step-Down prepayment penalty, also known as being on a declining or fixed schedule, is a predetermined sliding scale or fixed percentage which corresponds to the amount of time since the loan was originated.
A loan assumption occurs when a property owner sells a commercial real estate asset, with the secured CMBS loan attached. The buyer will then assume and continue making payments on this loan. The new borrower will be bound by the same loan documents, which allows the previous to avoid prepayment penalties.
Despite the fact that loan assumptions require fees, it affords the new property owner a more efficient financing process as opposed to procuring a new mortgage. Most CMBS loans are considered to be assumable, which provides options for borrowers and less prepayment risk to be absorbed by bondholders.
Which Types of Properties Are CMBS Eligible?
Commercial Mortgage-Backed Securities(CMBS loans) are primarily available for any commercial property type which produces stabilized cash flows. The types of properties that would include are:
- Multi-family properties (apartment buildings, duplexes, gated communities, etc.)
- Storage facilities
- Hotels and hospitality spaces
- Industrial buildings
- Retail spaces (malls, shopping centers, outlets, etc.)
- Office buildings
Loan minimums usually begin at one dollar. Maximum loan amounts are concluded based on perceived credit risk and are at the lender’s discretion.
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.
What Happens Once a CMBS Loan is Sold?
Once a CMBS loan has been sold into a CMBS trust, the borrower will work with a servicer otherwise known as a master servicer, rather than the original lender. The master servicer is responsible for handling the administrative aspects of the loan, which includes collecting payments from the borrower and managing escrow accounts.
If the borrower defaults on their loan, the loan in question is transferred to a more management-intensive servicer referred to as a special servicer. The CMBS special servicer is responsible for potentially modifying the borrower’s loan terms and helping the property return to achieving a stabilized level of operating performance. All modifications must be made while taking into account the bondholder’s best interests.
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“I would like to thank you in helping me purchase the 20 unit apartment building. You guys were very helpful and found me a good rate! I closed yesterday and I can’t thank you enough.”