What is a CMBS loan and why do you care?

Question

A CMBS loan or Commercial Mortgage-Backed Security loan, also called a Conduit Loan, is a unique method of securing financing for stabilized revenue-generating investment properties.  These loans are not as familiar to investors as traditional loans, although they have been in play since the 1990s.  Funds for these type of loans are sourced from securities.  The security is then collateralized by commercial real estate notes.  These loans are used for stabilized revenue-generating commercial properties such as apartment buildings, office complexes, mixed-use real estate, or hotels.  CMBS loans have advantages over traditional financing.  They are non-recourse, meaning a borrower can avoid signing a personal guarantee and fixed interest rates for five to ten years.  Also, expect a term of ten years with an amortization of about 25 years.  CMBS loans are generally 75% LTV based on appraisal.  Currently, rates can be as low as 4.75%, which is a big advantage considering that, generally speaking, conduit loans are not credit-driven therefore, low credit scores have absolutely no impact on the financing.  The underwriting decisions are made based primarily on the asset's cash flow.  There are some disadvantages, such as, owing a prepayment penalty and a balloon payment at the end of the term; however, refinancing is always an option.  Once again, these loans are a great solution for an investor seeking to acquire or refinance a stabilized, revenue-generating, non-owner occupied asset such as apartment buildings, office complexes, mixed use real estate, or hotels.

Joel Owens · Answer

CMBS took a big hit the first quarter of this year because they price interest rates too high in the 5's.

Even though CMBS can be non-recourse you still have to sign carve outs for things like bankruptcy and fraud where it changes to recourse.

CMBS also has a lot of loan costs with it in lender legal fees to securitize the debt. Local bank attorney legal might be zero sometimes if you use their boiler plate forms for recourse. If you want to get an attorney to negotiate a custom loan note then the bank generally charges about 4,000 for their attorney.

CMBS you can spend 15,000 to 25,000 for lender legal. If the buyers attorney is not skilled and the lenders attorney has to pick up the slack the bill can climb even higher.

CMBS you have a pre-pay because the mortgage debt is sold off and the note investors are guaranteed a fixed return for set period of time. That is why if it is paid off early there is a big penalty that  generally reduces year over year to a smaller amount as the fixed loan term draws to and end.

What happens is a buyer might assume the loan in place for the 1% assumption fee or ask the seller to pay the fee to break the loan. The buyer and seller might also split the break fee 50/50 or some other percentage. The seller might also demand the buyer pay the whole break fee.

On a CMBS loan since they are going to 75% ltv non-recourse the properties books need to be close to perfect and the asset has to be high quality in a desirable location. The loan amount is also a minimum of 2 million and generally most will not go below 5 million.

Don't expect a CMBS lender to loan on a small property in an obscure area for non-recourse.

If you put 40% or more down life insurance companies can have great rates and programs. Some local banks and credit unions have recently added 7 to 10 year fixed and 25 year amortization for commercial loans. We used to do more CMBS but now banks are being competitive. With a bank sometimes you can negotiate partial recourse and have it burn off when the LTV drops to a certain point. Banks typically have a 5/4/3/2/1 pre-pay penalty but sometimes you can get it to 3/2/1 with committee approval.

I do not do the loans but broker the transactions as a commercial broker. Financing kills deals so you have to know the numbers and what is possible. I find many buyers even those with capital do not understand the nuances of financing in the commercial space.

Joel Owens · Answer

With CMBS to hit the 75% LTV the property has to be very strong in higher cap rate, location, and quality.

Anything found under due diligence can change the scope of what was initially quoted to fund.

An example is the seller saying 5% vacancy and the average per the appraisal being more conservative is 9%. The lender now says instead of 75% LTV they will do 71%. So now the buyer on a 10 million property has to put down 2,900,000 versus 2,500,000. Especially at a 4.75% fixed rate the property has to be very strong.

It is VERY important for an investor when looking to buy a property to be conservative on a loan. Plan for the worst but hope for the best. This way you are not hit with whoppers on the loan requirements at the last minute.

Since CMBS is non-recourse they tend to impose impound accounts (lock box) where the buyer has to send all rents first and reserves, mortgage, etc. is taken out and what is left over is sent to the owners designated account.

So with a bank with recourse they give you more leeway to do things on your own but with a non-recourse lender they want to be protected and not leave things to chance. So with CMBS you lose a little more of your cash flow control.

Most will not go above 75% ltv and if they do the interest rate rises substantially because the lenders loss risk position is increased.

With each property you have to find the best debt available. CMBS might not go into an area because population levels are not 50,000 in a 5 mile radius but a local bank bullish on commercial lending might give a 10 year fixed loan in the 4's because the vice president drives by the property on his way to work everyday.

Everything is situational. I have personally made hundreds of calls or more to different lenders over the years for CMBS, Life Insurance, conduit, private sources, small banks, regional, large banks, credit unions,etc.

I do it because I do not like leaving things to chance. I work with lenders I know and have a track record with and will not quote and re-trade mid deal unless there is a good reason for it. That is why we review almost everything in LOI to look for deal killers before the buyer spends money in a purchase and sale phase.

Some mortgage brokers want a buyer to go to purchase and sale fast and then spend,spend,spend with lender deposits and ordered reports to move quickly to closing. A buyer can be out tens of thousands of dollars with reports and attorneys fees that way. Doesn't make sense to spend 4,500 on an appraisal when the inspection hasn't comeback yet. You want the seller to agree to fix the issues before getting too far down the rabbit hole where you can't get back out if you need to.

Another thing sellers like to do is give due diligence piece meal. We generally have language that due diligence period doesn't start until all items listed are received. That keeps them from playing games because until all the docs come in the clock doesn't start.

Whatever direct lender or a mortgage broker a buyer is dealing with do not pay them anything until closing. A lender ordered deposit is typical but make sure it goes to the lender directly. If the lender is requiring proof to earmark a certain amount of reserve money you could have your attorney hold it and provide a letter showing the funds are there in a specific account.

There are a lot of lenders out there who are fee takers and non-performers or they re-trade the loan and claim they can no longer do the loan.

Mortgage brokers earn their fee at get paid at closing and not one second sooner. If they take a small non-refundable deposit as part of their fee upfront watch out. They now have made some money and whether the loan closes or not they were paid ( fee takers ). If the mortgage broker gets nothing until it closes you better believe they will heavily vet the lenders ability to close and not re-trade mid deal because they know it will be a waste of time. If the mortgage broker gets 2,500 to 5,000 upfront they might roll the dice on a lender with your earnest money money at stake. You could then lose your earnest money all together if outside the finance contingency period of the contract and having to ask the seller for an extension to fund and close.

Typical fee is 1% to mortgage broker paid at closing UNLESS the deal is real small then some have 10k minimums or higher or they will not work the file. You can finance the fee into the loan sometimes if the LTV is low around 60% or less. At 75% ltv generally it pushes the ltv too high for the lender to add in mortgage broker or other fees into the loan.

Scott D Fitts · Answer

Thank you for this post @Nathan Click. I have been looking for some information like this for some larger multi's I have been looking at. Adds a little more to possibilities.

Nathan Click · Answer

Joel Owens,

Thanks for your comments, it is important to understand the details of a financing transaction.  A CMBS loan is not the best solution in all cases but it is a fabulous solution for those investors looking to finance or refinance a property without submitting to personal guarantees or typical credit checks.  Generally seeking the decision to commit funds to a project is based on the assets profitability.   You are correct in saying that legal can be a high initial cost, which is why most borrowers considering CMBS will likely be looking a projects $3M and up.  Having said that our lenders are willing fund projects as low a $1M.  As far as the asset's books, perfection or even near perfection is not a requirement.  The property does need to be generating revenue and be stabilized as long as we can prove that and the debt service is acceptable the deal is doable.

What is a CMBS loan and why do you care?

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