Understanding the Factors Impacting CMBS Rates
CMBS loan rates are generally based on the U.S. Treasury Index, plus a margin, also known as a spread, which compensates a lender for their risk and provides for their profits.
CMBS Loan Rates: The Basics
Interest rates for CMBS loans vary by the day but usually stay within a tight range for most borrowers, with exceptions for particularly desirable or particularly risky properties. CMBS loan rates are generally based on the swap rate, plus a margin, also known as a spread, which compensates a lender for their risk and provides for their profits. Of course, CMBS loans are later securitized and sold to investors, so the spread also provides for the investors’ profits.
Factors That Influence CMBS Spreads
A variety of factors influence CMBS spreads; those that increase risk cause spreads (and interest rates) to rise, while those that reduce risk reduce credit spreads. Some of the most influential factors include:
Property Type/Condition: Hospitality properties are generally some of the riskiest property types eligible for multifamily loans, while the safest property types include traditional multifamily and commercial properties. In addition, higher quality properties (think Class A) are less risky, while poorer quality properties (think Class C) are riskier and command higher spreads.
Cash Flow/DSCR: The greater a property’s cash flow relative to its debt obligations, the safer a loan will be, and the lower its spread (and vice versa). The minimum DSCR for most CMBS-eligible property types is 1.20-1.25x DSCR, but riskier property types may need 1.40-1.50x DSCR to qualify.
Loan Term/Size: Larger loans typically have lower credit spreads, while longer-term loans have higher spreads. For instance, a large, short-term loan would have the smallest spread, while a smaller, long-term loan would have the highest spread.
Leverage/LTV: The average maximum LTV for a CMBS loan is 75%, but this can vary based on other risk factors. Highly desirable properties may be permitted LTVs up to 80%, while riskier properties may only be allowed 70%. Higher LTVs typically lead to higher spreads, as they increase the risk for lenders.
Lease/Tenant Strength: If the tenant in a commercial property is a large corporation with a long-term lease (for instance, if a credit tenant lease is involved), CMBS spreads are usually lower, while smaller or lesser known tenants may face higher spreads.
What are the key factors that influence CMBS rates?
The key factors that influence CMBS rates are inflation, economic uncertainty, bond maturity, and quality/rating.
Inflation can affect market-wide supply and demand, which can have a trickle-down effect on CMBS loan rates/spreads. Economic uncertainty can cause investors to flock to U.S. treasury bonds, driving down their rates, and therefore increasing the difference between treasury bond and CMBS yields. Credit spreads are typically larger for bonds that have longer maturities, as this increases the amount of risk for potential borrowers. Commercial mortgage backed securities composed of loans taken out by higher risk borrowers will naturally have a larger credit spread than those composed of lower-risk loans.
Sources: Understanding the Factors Impacting CMBS Rates and What are CMBS Spreads?
How do changes in the economy affect CMBS rates?
Changes in the economy can affect CMBS loan rates by influencing market-wide supply and demand, which can have a trickle-down effect on CMBS loan rates/spreads. Economic uncertainty can also cause investors to flock to U.S. treasury bonds, driving down their rates, and therefore increasing the difference between treasury bond and CMBS yields. This is explained in more detail in the article What are CMBS Spreads?.
What is the difference between a CMBS loan and a traditional loan?
CMBS loans are typically much easier to apply for and get approved for than traditional loans. CMBS lenders are not as concerned with factors such as credit scores and net worth, whereas traditional lenders usually prioritize these factors. CMBS loans are also pooled together and sold to investors on the secondary market, whereas traditional loans are kept on the lender's balance sheet.
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How do CMBS loans compare to other commercial real estate financing options?
CMBS loans are a type of financing that is provided by lenders who package and sell mortgages on to commercial mortgage-backed securities (CMBS) investors. These investors then receive the mortgage payments from borrowers. CMBS loans can be advantageous because they don’t require much scrutiny of a borrower. Rather, the loan is underwritten on the financial strength of the asset held as collateral.
CMBS loans are generally provided with fixed interest rates and have terms of five to 10 years, with amortization periods of up to 30 years. CMBS loans are available for most types of commercial real estate assets, but they may be harder to come by in smaller markets. This type of loan can be used to fund an acquisition or for a refinance.
For borrowers with sufficient cash, say, 25%, who want to purchase an income-producing property, a CMBS loan is often significantly easier to get approved for, and will usually offer rates very competitive with bank financing (if not substantially better). In many cases, banks will only offer 5-year loans for commercial properties, and will generally put a lot of emphasis on a borrower’s credit score, net worth, and commercial real estate experience. This is not the case for CMBS financing, where the property itself is the most important factor in the loan approval process.
Unlike banks, which generally keep loans on their balance sheets, CMBS lenders pool their loans together, creating commercial mortgage backed securities, and selling them to investors on the secondary market. Due to risk retention rules, CMBS lenders do have to keep 5% of each loan on their balance sheet. However, this does not generally change anything for the average borrower.
Unlike borrowers for commercial bank loans, CMBS borrowers will not continue to deal with the same lender that originated their loan during the remainder of its life; instead, they will have to work with a loan servicer, referred to as a master servicer. If a borrower defaults on their loan, they will have to work with another type of servicer, known as a special servicer. This is not always ideal, as a special servicer will generally put the investor’s needs (and their interests) above the needs of the borrower.
What are the advantages and disadvantages of CMBS loans?
The Benefits and Drawbacks of CMBS Loans:
The major advantage of CMBS loans is the low interest rate financing they provide to borrowers who otherwise might not qualify. CMBS financing occupies an incredibly useful niche in the industry.
The major downside of CMBS loans is the difficulty of getting out the loan early. Most, if not all CMBS loans have prepayment penalties, and while some permit yield maintenance (paying a percentage based fee to exit the loan), other CMBS loans require defeasance, which involves a borrower purchasing bonds in order to both repay their loan and provide the lender/investors with a suitable source of income to replace it. Defeasance can get expensive, especially if the lender/investors require that the borrower replace their loan with U.S. Treasury bonds, instead of less expensive agency bonds, like those from Fannie Mae or Freddie Mac.
In addition, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, it should be noted that most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes. However, this is not necessarily a con, since many other commercial real estate loans require similar impounds/escrows.
What are the risks associated with CMBS loans?
The major downside of CMBS loans is the difficulty of getting out the loan early. Most, if not all CMBS loans have prepayment penalties, and while some permit yield maintenance (paying a percentage based fee to exit the loan), other CMBS loans require defeasance, which involves a borrower purchasing bonds in order to both repay their loan and provide the lender/investors with a suitable source of income to replace it. Defeasance can get expensive, especially if the lender/investors require that the borrower replace their loan with U.S. Treasury bonds, instead of less expensive agency bonds, like those from Fannie Mae or Freddie Mac.
In addition, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, it should be noted that most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes. However, this is not necessarily a con, since many other commercial real estate loans require similar impounds/escrows.
How do CMBS Rates Compare to Other Commercial Loans?
Right now, CMBS loans are quite competitive, especially since they often have relaxed borrower requirements and are generally more asset-based (at least when compared to HUD, Fannie Mae®, and SBA 504 loans). For borrowers who qualify, HUD/FHA multifamily loans, life insurance company loans, Freddie Mac® Multifamily and Fannie Mae multifamily loans can often be less expensive than CMBS. For owner-occupied commercial real estate, SBA 504 loans can also sometimes be less expensive than CMBS. Traditional bank loans, in some cases, can be less expensive, but, more often than not, end up being pricier than conduit financing.
As one might expect, soft money loans, hard money loans, bridge loans, and commercial construction loans are, in general, significantly more expensive than CMBS, as they deal with riskier situations, which naturally must be factored into the interest rate.