A type of commercial real estate loan, a commercial mortgage-backed securities (CMBS) loan is used to buy commercial properties such as warehouses, office buildings, and multi-family living communities. Also known as a conduit loan, a CMBS loan differs from a traditional commercial loan in a number of ways. First, borrowers with traditional commercial loans pay back their lenders over time. With a conduit loan, the lender combines multiple CMBS loans and converts them into bonds, which are then rated based on criteria such as the number of loans in the pool and their average loan amount. This securitization process gives the CMBS loan its name.
After the bonds are rated, real estate investors purchase them based on these ratings. Following the purchase, the original lender receives payment, minus a percentage for risk retention. As a result, the lender retains more capital to fund additional loans. A CMBS loan has a fixed interest rate and a typical amortization period of 25 to 30 years, although some offer as short as a 10-year amortization. They usually require a balloon payment at the end of the term.
Because the loan does not appear on the conduit lender’s balance sheet, lenders are able to provide financing to borrowers while maintaining liquidity. Borrowers seeking higher leverage with lower fixed rates often find that conduit loans have much less red tape involved than traditional commercial mortgage loans. This type of loan is particularly beneficial for borrowers seeking $2 million or more with up to 75 percent leverage.
One of the primary advantages of a CMBS loan is its flexible underwriting guidelines. While traditional commercial loans have stringent requirements for liquidity and credit history, CMBS loans are available to a much wider range of borrowers, even those with previous bankruptcies or bad credit. CMBS loans are non-recourse, which means that the lender cannot attempt to repossess the borrower’s personal property in the case of default. However, like non-recourse commercial real estate financing, CMBS loans typically include “bad boy carve outs,” where specific conditions such as fraud can cause the loan to become full-recourse.
Another advantage of CMBS loans is their competitive rates. Banks will often only offer 5-year loans for commercial properties and will focus on the borrower’s net worth and past experience. Meanwhile, in CMBS financing, the property itself plays an important role in loan approval. In addition to their competitive rates, CMBS loans are assumable for a small fee. If a borrower wants to exit the property before the loan term ends, they can do so without facing huge prepayment penalties. Assumable loans also make selling a property easier, as the new owner and borrower will only need to receive approval, rather than going through the entire approval process (which typically includes hefty legal fees).
CMBS loans also allow for cash-out financing. Companies that want to take equity out of commercial properties to fund renovations or expand their business can do so much more easily with CMBS financing than with traditional bank loans.
Overall, CMBS loans expand access to real estate investment for borrowers who wish to purchase properties that are not eligible for bank financing. The loan type is not without risk, especially for borrowers who may be unable to make loan payments or who require a more flexible loan structure. Therefore, potential borrowers should contact a trusted firm to determine whether it is the best choice for them.
