Understanding the Structure and Benefits of CMBS Loans
CMBS loans have become popular in 2024 as regional and local banks have slowed or halted new loan production. For those that aren’t as familiar with the CMBS product, the loans are heavily structured and largely originated by lenders with little to no customer relationship. The loans are quickly sliced, diced, pooled and converted into rated and non-rated bonds, which are sold to investors.
There are times that CMBS can be the right source for financing commercial real estate. When banks and other balance sheet lenders pull back on lending, CMBS can provide needed capital.
Benefits to CMBS loans
- Non-Recourse
Benefit: CMBS loans are structured as “non-recourse,” which means they shield the borrower’s assets from potential attachment in the event of default on the loan.
Be aware: Non-recourse loans do have a drawback which must be considered. CMBS loans do not provide borrowers with an ongoing lender relationship, the way that a bank loan does. A lending relationship can come in very handy when an unexpected event occurs which threatens the borrower’s ability to pay the loan precisely in accordance with the loan documents. A lending relationship provides the parties an opportunity to come back to the negotiation table and collaboratively solve problems to maintain the original “spirit of the deal”.
If a CMBS loan falls into default, the real estate owner faces a greater risk of losing his or her property. The loan servicer is legally required to enforce the loan documents and cannot engage in a loan “work out” or restructuring.
Lastly, in place of a personal guarantee, non-recourse CMBS loans require mandatory cash flow sweeps, reserve account build-ups and other provisions that mitigate default risk for the bond investors (main owners of a CMBS loan).
- Full-term Interest Only Options
Benefit: CMBS loans are often being structured as full-term interest only loans, helping sponsors to maximize their cash flow. One reason for this is that the most subordinated buyers of CMBS loan tranches (those investors whose bonds carry the greatest risk in the event of default) are quite comfortable with owning the real estate collateral.
Be aware: Some of these investors purchase the most subordinated tranches of CMBS loans as a strategy to acquire commercial properties through foreclosure if the borrower is unable to fulfill all of the terms in the loan documents.
- Rate Buydowns to maximize Loan Proceeds
Benefit: CMBS loans are driven by cash flow, and the amount of proceeds is generally constrained by debt service coverage (DSC) ratios more so than loan-to-value (LTV) constraints. Therefore, using rate buydowns, real estate owners can maximize their loan proceeds. Often these rate buydowns can be funded through cash being returned to owners as part of the refinance.
Things to consider when evaluating a CMBS loan
Choose a respected lender: As part of the CMBS push, some CMBS lenders, in search of growing market share, are issuing non-binding, aggressively priced term sheets to attract commercial real estate owners. The CRE owner is usually required to put up non-refundable deposits on these non-binding quotes, and once the deposits are received, terms are often being retraded.
By their nature, CMBS transactions are very different from balance sheet lending. For balance sheet lenders, the customer relationship is at the center of every transaction. Balance sheet lenders write, hold, and manage the loans they close.
For a CRE owner, perhaps the greatest risk of a CMBS loan is what happens when a serious, unexpected event occurs. Once your loan is securitized, you lose your original point of contact for the loan. The new point of contact must explicitly follow the loan documents – no opportunity for negotiations.
It is important to choose a CMBS lender with a good reputation. I strongly suggest direct communication with senior management at the CMBS lender to help prevent surprises in the process. At Plum, we have senior executive-level relationships at highly esteemed CMBS platforms.
If you would like to explore financing options while rates are low, give me a call at 415.914.8260