Commercial Mortgage Backed Security (CMBS) loans are non-recourse commercial real estate loans. The CMBS structure provides borrowers access to the large fixed income capital markets. In addition, the tranching of CMBS bonds gives investors more tailored risk exposures.
CMBS loans are not kept on originators’ balance sheets (unlike portfolio financing).To achieve this end, lenders bundle commercial real estate loans into large pools, and sell them to trusts. Pools range from $500M to $2Bn in size, and contain anywhere from 30-200 loans
These trusts then issue a series of bonds that are collateralized by the bundled commercial real estate loans. A rating agency provides feedback to the issuer on how they will rate the pool (with AAA being the highest possible score). Higher-rated tranches are more expensive and possess lower potential yield levels. However, they naturally are also more conservative investments.
For bond buyers, the waterfall payment progression dictates rights to cash flows from loan proceeds. Each month the interest received from all of the pooled loans is paid to the investors. Investors holding the highest rated bonds are paid first, then the owners of the second highest rated bonds, and so on.
For borrowers, CMBS loans possess attractive characteristics, making them a strong candidate for many projects. When compared to Bank financing, CMBS loans are almost exclusively non-recourse (with the exception of fraud, waste, and environmental carveouts) and are predominantly fixed-rate. However, loan amounts over $25M may qualify for 2-3 year floating rates. They are typically longer in term than traditional Bank financing, and Life companies have trouble competing with their high leverage values. Overall, CMBS loans offer relatively low interest rates and maximum leverage.
Properties secured by CMBS loans must be stabilized, and generally cannot have too unique a use or tenant make-up. CMBS loans require a “defeasance” prepayment structure, as fixed income investors want to maintain their yield and call protection.
Important things to know as borrower:
- The lender is a conduit to the fixed-income bond market. This market demands standardized underwriting and loan structures, so CMBS loans are less flexible and customizable to the borrowers’ preferences.
- The originating lender does not necessarily service the loan. The borrower may be required to communicate with a third party that has no preexisting relationship with the borrower if any problems occur, or changes are necessary.