What Benefits and Drawbacks Do CMBS Loans Offer?

David Cohn
Jul 7, 2023
CMBS Loans

CMBS loans are accessible to many borrowers who may not qualify for traditional lending options. They are notable for their relaxed credit requirements and generally offer fixed-rate terms ranging from 5 to 10 years.

They also offer high leverage and competitive rates that can surpass those of comparable bank loans. But of course, CMBS loans have a long list of drawbacks, too, not the least of which are early loan repayment and tough prepayment penalties.

Nevertheless, it's crucial to acknowledge that CMBS financing occupies an advantageous market position in the industry, offering dependable and low-interest financing to borrowers who may otherwise be ineligible.

In this blog, we talk about the benefits and disadvantages of CMBS loans so that you can decide if it’s the right fit for your CRE project.

What are CMBS loans?

The term "CMBS" stands for commercial mortgage-backed securities, which are loans grouped together with similar loans sold as bonds to investors on the secondary market.

CMBS loans virtually disappeared after the 2008 market crash, but the market has since returned to life. Domestic issuance reached $109.12 billion in 2021, a massive 95% increase compared to the prior year.

CMBS loans have regained popularity because they offer high leverage, especially for properties in secondary and tertiary markets, as long as they meet the lender's debt yield requirement.What are the benefits of CMBS loans?

CMBS loans continue to be popular because they offer many advantages for certain types of CRE investors.

  • Firstly, they are accessible to many borrowers, including those who might be disqualified from traditional lenders due to bad credit, past bankruptcies, or strict collateral/net worth prerequisites.
  • Furthermore, CMBS loans are non-recourse. This means the lender cannot seize a borrower's personal property to repay the debt if they default.
  • Additionally, CMBS loans provide a high leverage, with most property types qualifying for up to 75% leverage and, in some cases, up to 80%.
  • Moreover, CMBS loans offer highly competitive interest rates, which can be lower than traditional bank loans.
  • Additionally, these loans are assumable, allowing borrowers to transfer their loans to new owners if they decide to sell their property before the loan term is up.
  • Investors can select the tranche they want to pursue based on their risk profile.
  • Another advantage of CMBS loans is the option for cash-out refinancing, which allows businesses to access the equity in their commercial properties to fund renovations or business expansion.

What are the drawbacks of CMBS Loans?

The primary disadvantage of CMBS loans is that it can be difficult to exit the loan early due to 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, which consists of a borrower purchasing bonds to repay their loan and provide the lender/investors with an appropriate income source.

The cost of defeasance can be high, especially if the lender/investors insist that the borrower use US treasury bonds instead of more affordable agency bonds (such as those issued by Fannie Mae or Freddie Mac).

Furthermore, CMBS loans generally do not allow secondary or supplemental financing due to the added risk it poses for investors. It's also important to note that most CMBS loans require borrowers to have reserves, which include funds set aside for insurance, taxes, replacement reserves, and other essential purposes.

This isn't necessarily a disadvantage, as it is standard for additional commercial real estate loans to require similar escrows or impounds, but it is worth mentioning.

Borrowers should also be aware that the lender will not service their loans. Instead, a master servicer is assigned to handle the loan. These services are solely focused on serving the interests of the CMBS investors, which may not always align with the borrower's best interests.

For example, suppose the borrower encounters difficulty making payments. In that case, 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 up on payments.

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.

How do CMBS loans compare to other types of CRE loans?

CMBS loans are more suitable for properties in secondary and tertiary markets due to their high leverage allowances. But for multifamily properties, Fannie Mae, Freddie Mac, or HUD/FHA multifamily loans may offer slightly better interest rates, less onerous prepayment penalties, and higher leverage allowances of up to 90% for affordable properties.

Life company loans offer lower rates and superior servicing for non-multifamily commercial properties as these loans are kept on their books. However, these loan types generally have stricter borrowing requirements and do not offer cash-out options, while some CMBS transactions do. Overall, the suitability of each type of financing depends on the borrower's specific needs and property type.

What are the standard interest rates for CMBS loans?

Although they fluctuate daily, CMBS loan interest rates typically remain within a narrow range and are determined based on the swap rate plus a margin. This margin compensates the lender for their risk and profit.

The current US treasury swap rates generally determine the interest rate for CMBS loans and are typically lower than traditional CRE mortgages.

In addition, while CMBS loans are usually fixed-rate, floating-rate options are also available, and conduit loans usually start at $2 million, with some lenders offering loans as low as $1 million.

What are the standard terms for CMBS loans?

Typical loan terms for CMBS loans usually range from 5 to 10 years, with 15-year terms being available in rare cases.

The loans come with a 25-30 year amortization period, with interest-only options often available for partial or complete terms. Borrowers can expect an LTV of up to 75% for conduit financing, but it can go up to 80% or higher if combined with mezzanine debt.

What types of CRE properties can be funded by CMBS loans?

CMBS loans are versatile financing options that can fund various commercial real estates properties such as retail, office, and mixed-use properties.

CMBS lenders typically prefer retail properties with strong anchor tenants managed by professional organizations. They also lend for the acquisition, cash-out, or rate and term refinancing of Class A and B office properties.

Mixed-use properties, ranging from small apartment buildings with commercial tenants to larger complexes with retail stores, restaurants, or entertainment businesses, are also eligible for CMBS loans.

How do you qualify for CMBS loans?

To determine whether to approve a CMBS loan, lenders evaluate two key metrics: debt service coverage ratio (DSCR) and loan-to-value ratio (LTV). Furthermore, lenders usually require borrowers to have a net worth of at least 25% of the loan amount and liquidity of at least 5% of the loan amount.

Aside from the DSCR and LTV, some lenders consider the debt yield, which is calculated by dividing the property's net operating income by the total loan amount. Many conduit lenders prefer a yield of 10% or more, though some may accept lower yields of up to 8% for exceptionally high-quality properties.

Unlike DSCR, debt yield cannot be increased through longer loan amortizations or interest-only payments. It can only be altered if there are changes to the income or loan amount, which makes it a more dependable risk indicator.

Also, CMBS lenders typically require borrowers to hold their property in bankruptcy-remote special purpose entities (SPEs) to minimize the lender's risk. If the borrower becomes bankrupt, this structure typically ensures that the property will not be part of the bankruptcy.

To successfully navigate the complex world of CMBS loans, it's recommended to seek the assistance of a consultant with expertise in refinancing existing CMBS loans and dealing with issues such as defeasance, cash flow, and depreciation.

In addition, it's essential to look for advisors who specialize in leveraging commercial mortgage-backed securities for financing commercial properties and who have a track record of success in funding various types of CRE properties, including office, retail, hospitality, apartments, mixed-use, self-storage, mobile home parks, and more.

Explore other financing options.

Aside from CMBS, plenty of other CRE funding sources are available, including hard money, bridge loans, and stated income loans. Talk to a CRE financing specialist about your requirements to get expert assistance finding the most suitable solution.

Capital Investors Direct is a top-rated investment advisory firm for commercial real estate in Rockville, Maryland.

We offer customized commercial loan options that may not be available through regular banks to commercial real estate investors across the country.

Our services include quick closings, competitive interest rates starting from 5%, a straightforward application process, tailored loan structures, and financing solutions for CRE projects of all sizes.