CMBS Loans and How They Work
If you’re in the market to purchase commercial property and are in need of the funds to make it happen, you’ve likely been researching every type of loan in the book. It can be a confusing process, with a wide range of different loan types, structures, providers, and servicing styles—how do you know which one is right for your unique situation and will serve you well? How do you know whether you’ll qualify?
One common form of commercial real estate loan is the CMBS loan. Also known as conduit loans, CMBS loans are commercial mortgage backed securities. What makes them distinct from traditional commercial loans is that they’re sold to investors around the country as packages on a secondary market. This process is officially called securitization. Because they have this unique second life on the secondary market, these loans can be structured differently and have different rules attached.
In this guide, we’ll help you understand exactly what a CMBS loan is, how it functions, how it’s different from other commercial real estate loans, and key pros and cons about choosing a CMBS real estate loan. We’ll also explain CMBS loan prepayment rules and detail who services CMBS loans and how you can qualify.
So without further ado, let’s master CMBS loans.
CMBS loans explained
A CMBS loan is like other commercial real estate loans in many ways, but with one key difference. When you receive the loan, it will come from the specific capital provider or bank that you approached and applied for the loan with — but it won’t stay that way. The loan will eventually be bundled up with other loans in what’s called a trust (specifically, a Real Estate Mortgage Investment Conduit). This trust, or REMIC, will then be sold to investors on the secondary market.
What does this mean for you? It means that CMBS real estate loans are structured slightly differently from other loans. It also means that who services your loan will be different, particularly when it comes to who you’re working with when you make payments on the loan or adjust the loans parameters as time goes on.
What are the most common CMBS loan terms and features?
You’ll recognize many of the terms that come up when dealing with financing CMBS loans for real estate. But the way they all function relating to the loan can be different than what you’re used to seeing. Here are some of the most common terms and features of CMBS loans and what you need to know about each one.
Recourse
In almost all cases, your CMBS loan will be structured as a non-recourse loan. What does that mean? It means that as the borrower, you aren’t held personally responsible for the loan’s repayment. This means that if the loan defaults or is foreclosed, the debt can only be repaid from any property used as collateral or cash flows resulting from the property. However, there are exceptions to this rule. If the borrower conducts activities that result in damage, harm, or lack of productivity to the property, the lender may have recourse in holding the borrower personally liable. These activities could include additional financing without the lender’s knowledge or consent, loan fraud, property transfer, and other activities.
Amortization & Term Length
Generally, CMBS loans features amortization periods of between 25 and 30 years. Term lengths tend to vary between 5, 7, or 10 years—with 15-year terms being extremely rare, but occasionally possible. Depending on the condition of the market, either all of or part of the term might be considered interest-only. As is the case anytime a loan’s term doesn’t match up with its amortization schedule, CMBS loans are designed to balloon at the end of their term. In simple terms, this means that at the end of your 5, 7, or 10 year loan, any balance on the loan that’s still unpaid must be paid immediately or refinanced into a new loan.
Prepayment Rules
We’ll dive into these in a bit more detail later, but in general prepayment penalty structures in CMBS loans are split into two categories— defeasance and yield maintenance. In both cases, prepayment of the loan can result in significant penalties depending on the status of the market or how long before the loan’s maturity date you plan to pay it off.
Defeasance
In this structure, collateral on the loan is replaced by bonds or securities and the loan remains unrepaid. This allows the property to then be refinanced or sold.
Yield Maintenance
Yield maintenance is designed to give investors in bonds the opportunity to keep receiving the same yield as if the borrower hadn’t prepaid, but rather continued making regular mortgage payments until the loan matures. Prepayment penalties are calculated based on a pre-established formula found in the original loan documents.
Loan Assumption
If the owner of a commercial real estate property financed through a CMBS loan wants to sell the property, it’s possible to transfer the CMBS loan to the new owner. This new owner will usually be bound to the exact same terms of the original owner—a powerful benefit if the market has since taken a downturn. They’ll get to enjoy the original, beneficial terms of the loan rather than new terms that may be poor relating to the market’s performance.
Primary Differences Between CMBS Loans and Other Loans
Generally, the main difference between CMBS loans and other standard commercial real estate loans is that the loan provider you deal with at the beginning is certain to change, as all CMBS loans are designed to be packaged and sold.
The other key difference you’ll want to be aware of is that CMBS loans that are prepaid before their maturity date will result in prepayment penalties, which can be significant. Borrowers should always take this into account when deciding on their preferred terms and amortization period for their CMBS commercial real estate loan.
CMBS vs. RMBS Loans
An RMBS is a residential mortgage-backed security. These function much like CMBS securities, but they of course feature bundles of residential mortgage loans rather than commercial loans.
Another key difference is in how terms of the two loan types are structured. In residential mortgage loans, terms are not always fixed. But commercial mortgages almost always have fixed terms, which means that CMBS securities feature a lower degree of prepayment risk that can cause problems for investors. Otherwise, CMBSs and RMBSs feature many of the same pros and cons, despite their focus on distinct property types in the commercial and residential sectors.
Pros and Cons of CMBS Loans
One of the best parts of CMBS loans is that they’re accessible to a wider range of borrower classes. This means that borrowers who might otherwise be unable to obtain a commercial real estate loan due to factors like bankruptcy history or bad credit may qualify for CMBS loans, whose qualifying factors aren’t as stringent.
Because CMBS loans are non recourse, this also means that borrowers don’t have to worry about lenders trying to take their personal property in case of loan defaults.
The major downside of CMBS loans for some borrowers is that they’re designed to make prepayment difficult, so getting out of a CMBS loan early is not easy
Who Services CMBS Loans?
Once a CMBS loan is bundled up with others and sold as a trust, that trust will feature what’s known as a pooling and service agreement, or PSA. This PSA is a document that lists how each servicing entity associated with the trust must operate and behave. It defines their responsibilities as the new servicer of these loans. The trustee who handles the trust serves as the de facto watchdog over these trusts, assuring that each loan within the trust is serviced according to the rules outlined in the PSA.
How does this affect you? In broad terms, it doesn’t. Not much will change in terms of when you make payments, how much those payments are, and other loan factors. What will change is who receives those payments and who you come to with questions or to make changes to your loan.
Qualifying for a CMBS loan
While the terms surrounding CMBS real estate loans may be confusing, the truth is that they’re highly advantageous for many real estate investors and other borrowers. The commercial mortgage brokers at Clopton Capital of extensive experience with CMBS loans on all property types and they can help you qualify your property today.