Commercial mortgage-backed securities (or CMBS for short) are also known as conduit loans. These types of loans are secured by mortgages on commercial real estate rather than residential properties. They are useful in that they are a way of providing liquidity to both real estate investors and lenders.
CMBS have become more and more popular over the past few years among real estate investors due to the rising prices in real estate properties. Whether you’re an investor or a lender, commercial mortgage-backed securities are an important piece of real estate finance to understand. In this article we’re going to break down what exactly CMBS loans are, their advantages, features, and how they provide liquidity in the commercial mortgage market.
Commercial mortgage-backed securities are essentially groups of loans that are packaged together and sold on a secondary market. These packaged loans called are often segregated into separate groups (called “tranches”) depending on their credit rating. CMBS are sold by conduit lenders, commercial banks, investment banks, or even syndicates of banks.
As mentioned earlier, CMBS loans are specifically meant for commercial real estate and differ from their residential counterparts, RMBS loans. Although CMBS are not standardized, they do tend to be thought of as less risky than RMBS due to the ubiquity of fixed terms in commercial mortgages. These fixed terms reduce prepayment risk.
When it comes to commercial mortgage-backed securities, you can think of them as a mortgage that is made up of other existing loans, all put together in a pretty little package and, bonus, securitized. After all of this, the mortgage is sold to investors and held in a trust where it acts as collateral for the mortgage backed security.
As you might have been able to tell, CMBS loans are a bit more complicated than traditional loans. Their additional complexity is often worth it to real estate investors and lenders for the fact that CMBS loans are able to provide liquidity for both parties involved. On the secondary market, commercial real estate investors that may not be able to meet conventional liquidity and net worth guidelines are given the opportunity to invest in commercial real estate. The securitization of the mortgages ensures that they can be bought and sold more efficiently, thus increasing liquidity.
Features of CMBS Loans
In order to get a complete understanding of how CMBS work, it’s important to take a look at several of their features. Below is a list of a few vital features that make up commercial mortgage-backed securities.
Term Length & Amortization — When it comes to CMBS loans, they generally have a term length of anywhere from 5-10 years with 25-30 year length amortizations. Since the terms of these loans don’t meet the schedule of the amortization, there is always a balloon payment at the end of the loan where the remaining loan balance is either paid in full or refinanced.
Prepayment Penalties — With CMBS loans there are two different types of prepayment penalties, yield maintenance and defeasance. During a yield maintenance penalty, the loan is paid off in full and the mortgage note is cancelled. In a defeasance penalty, there is a substitution of a source of collateral, generally the property involved, with another source of collateral, usually treasury bonds.
Yield Maintenance — In CMBS loans, yield maintenance is when the bond investors maintain the same yield as they would have if the borrower made all the scheduled loan payments.
Defeasance — Defeasance with CMBS loans means that the loan has not been repaid and the mortgage note is still in place. When this occurs, the collateral on the property, generally bonds, replaces the commercial real estate so that the particular piece of property is able to be sold or refinanced by lenders.
Loan Assumption — Nearly every CMBS loan is considered assumable although this generally requires a fee. Loan assumption happens when an owner sells a commercial real estate asset that is securing a CMBS loan to a buyer who is interested in assuming said loan. Once the current owner sells their commercial property, the new owner is bound by the same terms and agreements of the existing loan. This way the original owner of the property is able to avoid defeasance or prepayment costs and give the new owner of the property a more favorable loan than the current market can offer.
Advantages of CMBS Loans
One of the major advantages of investing in commercial mortgage-backed securities is that CRE investors can achieve a higher yield than they would otherwise receive with government bonds. Investors can pick and choose which tranches of CMBS they would like to purchase, in order to align their risk/reward profile. The additional pool of capital that the secondary market provides increases commercial loan liquidity, thus lowering the cost of commercial debt.
When it comes to commercial mortgage-backed security loans, the bottom line is that they are a great option for both borrowers, investors, and lenders of commercial real estate properties. These particular products, while more complex than a traditional loan, offer advantages and benefits to both parties when dealing with commercial real estate investments.