Notable for their relaxed credit requirements, CMBS loans are accessible to many borrowers who may not qualify for traditional lending options. They also offer competitive rates and high leverage that often surpass comparable bank loans.
But is it the right financing for your project? Here are the basics to know if you plan to use CMBS loans to buy a commercial investment property.
CMBS loans defined
A Commercial Mortgage-Backed Securities loan, also known as a conduit loan, is a commercial real estate loan secured by a first-position mortgage on a commercial property.
Banks and conduit lenders offer CMBS loans to CRE investors who seek lower fixed interest rates and higher leverage.
Once issued, these loans are bundled into a Real Estate Mortgage Investment Conduit, which is then securitized and sold on the secondary market.
Properties eligible for CMBS loans
CMBS loans may be used on a variety of property types:
- multifamily properties
- apartment buildings
- office buildings
- hotels
- retail
- industrial
- self-storage properties
These loans can also fund unusual commercial properties like parking lots, hospitals, or marinas. However, CMBS lenders tend to offer stricter terms for these riskier properties.
For example, lenders usually require flagged hotels to have a DSCR of 1.40x, while unflagged hospitality properties(those without recognized affiliations or hotelier names) often need a DSCR of at least 1.50x.
General loan terms for CMBS loans in 2024
- $2 million minimum loan amount
- Fixed-rate loan terms of five, seven, or ten years
- Interest rates start at 200 basis points above the relevant Treasury rate
- A 30-year amortization period
- Up to 75%-80% maximum LTV
- A minimum DSCR of 1.25x
- Non-recourse with standard carve-outs
Benefits of CMBS loans
CMBS loans continue to be popular because they offer many advantages for certain types of CRE investors.
- They are accessible to borrowers who might be disqualified from traditional lenders due to bad credit and past bankruptcies and those who don't satisfy strict collateral/net worth prerequisites.
- CMBS loans are non-recourse. This means the lender cannot seize a borrower's personal property to repay the debt if the borrower defaults.
- CMBS loans provide high leverage (with most property types qualifying for up to 75% leverage and, in some cases, up to 80%).
- CMBS loans offer highly competitive interest rates, which can be lower than traditional bank loans.
- These loans are assumable, allowing borrowers to transfer their loans to new owners if they sell their property before the loan term ends.
- Investors can select the tranche they want to pursue based on their risk profile.
- CMBS loans provide the option of cash-out refinancing, which allows businesses to access the equity in their commercial properties to fund renovations or business expansion.
Here a complete guide on Commercial Mortgage-Backed Securities loan for detailed information
Disadvantages of CMBS loans
- Exiting a CMBS loan early can be difficult because of high prepayment penalties.
- While some CMBS loans allow yield maintenance (which involves paying a fee based on a percentage to exit the loan), other CMBS loans require defeasance (purchasing bonds to repay their loan and providing the lender/investors with an appropriate income source).
- Defeasance costs can be high, especially if the lender insists on using US treasury bonds instead of agency bonds.
- CMBS loans typically prohibit secondary or supplemental financing because of the increased risk this presents to investors.
- Most CMBS lenders require borrowers to set aside reserve funds for taxes, insurance, and other related purposes. (This isn't necessarily a disadvantage, as it is standard for different types of commercial real estate loans to require similar escrows or impounds, but it is worth mentioning.)
- The lender does not service CMBS loans and is instead assigned to a master servicer. These services are solely focused on serving the interests of the CMBS investors, which may not always align with the borrower's best interests.
If the borrower can't make payments, their loan may be transferred to a special servicer who can modify loan terms or even forgive or defer interest or fees to help the borrower catch.
However, these modifications will only be made if the special servicer believes they are in the best interest of the investors. If not, foreclosure is a possibility.
CMBS loans vs. other types of CRE loans
CMBS loans may be suitable for investors eyeing properties in secondary and tertiary markets because they allow high leverage.
But when it comes to multifamily properties, loans from Fannie Mae, Freddie Mac, or HUD/FHA multifamily loans often edge out CMBS loans with slightly better interest rates, more forgiving prepayment penalties, and leverage up to 90% for qualified, affordable properties.
On the other hand, life company loans are more attractive for non-multifamily commercial properties due to their lower rates and better loan servicing.
However, they have stricter borrower requirements and don't offer cash-out refinancing like some CMBS loans. The best financing option depends on the borrower's needs and the property type.
Qualifying for CMBS loans
- To be eligible for a CMBS loan, lenders look at the debt service coverage ratio (DSCR) and the loan-to-value ratio (LTV).
- They also require borrowers to have a net worth of at least 25% of the loan amount and liquid assets of at least 5% of the loan amount.
- Debt yield is another critical factor. Many lenders prefer 10% or higher yields, though some may accept 8% for top-quality properties. This metric — which shows the net operating income divided by the total loan amount — is a stable risk indicator that doesn't change with loan term adjustments.
- Lenders also require that borrowers hold their property in a bankruptcy-remote SPE to protect against the borrower's bankruptcy.
Other financing options
Beyond CMBS, various CRE financing sources include hard money, bridge loans, and stated income loans. Consulting with a CRE financing specialist can help identify the most fitting solution for your needs.
Capital Investors Direct offers specialized commercial loan solutions nationwide. You can expect quick closings, competitive rates, a straightforward application process, customized loan structures, and solutions for all sizes of CRE projects. Contact us today for a consultation about using a CMBS loan to find your commercial property project.
