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What is a Commercial Mortgage-Backed Security Loan?
Commercial mortgage-backed security (CMBS) loans are a type of popular commercial real estate loan secured by a first-position mortgage for a commercial real estate property.
They are offered by conduit lenders, as well as investment and commercial banks. To help with your property debt research, in this post, we explore the ins-and-outs of CMBS loans, providing detailed insights into features, typical amortization rate, and servicing.
CMBS Loan Features
A CMBS loan comes with fixed interest rates and typically offers terms of 5, 7, or 10 years. A CMBS loan is generally amortized over a 25-30 year duration, with a balloon payment being paid or refinanced at the end of this period. A CMBS loan acts as a secondary loan to the borrower, as it is not recorded on the books of a lender, allowing the lender to maintain their liquidity.
CMBS loans are nonrecourse, this eradicates personal liability for the borrower, allowing the commercial property and its profits to be used as collateral. However, a lender can pursue legal action if a borrower purposefully damages the property.
A conduit loan is also fully assumable. This means that if the borrower decides to sell their commercial property, they can pass the loan on to the buyer. In some circumstances, the borrower may have to pay an extra fee to the conduit lender to undertake the CMBS loan assumption process.
CMBS Underwriting Parameters
CMBS loans are popular with many commercial real estate investors for their forgiving underwriting parameters. Many CRE investors can access this type of loan even if they do not meet the typical demands issued by local savings banks.
Conduit loans are guided by two underwriting parameters: the debt service coverage ratio (DSCR) and the loan to value ratio (LTV). The DSCR is the ratio of the net operating income to annual debt. The DSCR is determined solely by the lender and varies depending on the level of risk associated with the property. For example, offices are generally seen as less risky than land investments by CMBS lenders.
The LTV ratio is the ratio of the total sum of money borrowed in comparison to the value of the commercial property. The value of the loan is determined by the lender and an independent third-party appraisal firm. LTV guidelines are based on the amount of risk for the lender: the higher the risk, the lower the LTV.
Both are taken into account in order to arrive at the maximum loan analysis, in conjunction with a predicted debt yield of at least 7%. This allows lenders to determine the maximum amount that they can lend. CMBS loans typically offer investors higher maximums of 75%.
The loan size is then determined by a borrower’s net operating income (NOI) rather than future profit predictions. Expense ratios and vacancies on the market are also accounted for.
In addition, CMBS lenders will also need to see evidence that borrowers have equity of around 30-40%. Borrowers also need a liquidity of 5% of the total sum to be loaned. Collateral, such as property or bonds, must also be agreed to before a CMBS loan is drawn up.
How a CMBS Loan Works
A conduit loan is pooled with a diverse selection of mortgage loans, placed into a Real Estate Mortgage Investment Conduit (REMIC) trust, and then sold to investors. Each loan sold to an investor carries with it a risk equal to its rate of return. This is known as the CMBS securitization process.
After the borrower has been given their loan by the lender, all their future dealings will take place with a commercial mortgage servicer, called a master servicer. The master servicer will collect all future CMBS loan payments.
However, if the borrower fails to make the payments due on their loan then a special servicer will step in and will work with the borrower to make changes to the terms or fees of their loan. Alternatively, the lender may allow them to pay collateral.
CMBS Loan Prepayment Penalties
CMBS loans also come with prepayment penalties: defeasance and yield maintenance. In the case of a CMBS yield maintenance penalty, the borrower pays a penalty for refinancing their loan or paying it off early. This allows the lender to make the same profit that they would have made if the loan had been paid off within the agreed timeframe. In this instance, the borrower’s note is canceled and the loan is paid off.
In contrast, the CMBS defeasance penalty does not allow for the loan to be repaid or the borrower’s note to be canceled. Instead, the commercial property is replaced by alternative collateral, such as bonds, allowing the borrower to sell or refinance the property. Lenders typically won’t allow borrowers to defease their conduit loan until two years have passed.
CMBS Loans Simplified
Commercial mortgage-backed security loans offer low interest rates and lax underwriting parameters to CRE investors. They are also an appealing choice because they are non-recourse and fully assumable.
If you’d like to contrast and compare the ways in which commercial mortgage-backed security loans stack up against other popular commercial loans, check out our past blog post.
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