Using CMBS Loans for Commercial Real Estate
Companies in the market for a commercial real estate loan have some options that residential real estate buyers can’t access, such as CMBS loans, or conduit loans. CMBS stands for commercial mortgage-backed securities. This type of loan is not held by the lending authority but is securitized and sold on the securities market as a package with other similar loans. For lenders, this is an attractive option because it allows them to lend money without carrying the loan against their liquidity position. For borrowers, conduit loans can be a valuable source of funding, but some pros and cons need considering before pursuing this line of credit.
There are several advantages for a commercial enterprise wishing to fund their real estate acquisitions through CMBS loans. The largest advantage is the ability for the borrower to transfer ownership of the loan to a new party upon sale of the property. In this case, the new owner of the property would take on repayment of the existing loan as part of the real estate purchase. This feature allows for the original owner of the property and the loan to avoid paying estate taxes on the property.
Other benefits of conduit loans include access to a higher loan-to-value ratio when determining the amount of the loan available to the borrower, which allows the borrower to access more of their property’s equity value when applying for the loan. CMBS loans also increase the company’s ability to obtain insurance money if the business needs to rebuild, although, there are restrictions on this.
Despite these benefits, there are drawbacks to the business when taking out a conduit loan. The largest of these is the loan must be carried for its full term, usually 10 years. During most of this period, the holder of the loan is not allowed to make prepayments to the loan, with very limited exceptions. A second drawback businesses must consider is that the lender only considers current cash flow when reviewing the loan application. Any future income or increases in rent are not factored into the value of the property. Finally, the business applying for the loan must be a single purpose entity whose only reason for existence is to take on the burden of the loan.
For businesses seeking to purchase commercial property, CMBS loans are a viable option as long as the risks are understood. Unlike residential real estate loans, conduit loans are available through a variety of sources including life insurance companies, pension companies, financial services firms and large banks. While each source has its lending requirements, a carefully planned CMBS loan can be a good way for a business to obtain funding for expansion.