Finance · October 22, 2020

Determine if CMBS Loans Are the Right Move for Your Organization

Owning a building in a separate limited liability company and having a business pay rent to that LLC can be another means of diversifying ownership risk and building wealth for business owners. As an owner, you may not be aware that there are various forms of mortgage funding available to you. You may be familiar with traditional bank-financed mortgage loans and SBA-guaranteed mortgages, but have you heard of the commercial mortgage-backed security, or CMBS loan? Because there are distinct differences, it's important to understand the pros and cons of CMBS loans.


CMBS loans defined

CMBS loans have been popular with real estate investors for a while. Here, a property's mortgage is underwritten by a commercial or investment bank—or an alternative lender—to secure the loan. Qualifying properties include offices, warehouses, retail buildings and shopping centers, as well as apartments and hotels.

Unlike portfolio loans, where your bank or other lender keeps the loan on its books as part of its portfolio, CMBS loans are packaged with hundreds of other similar loans. During a process called securitization, the loans are divided into segments called tranches and rated by credit rating agencies. The loans then morph from individual mortgages into financially engineered debt instruments. These new securities behave similarly to bonds in many ways, but unlike pure bonds, the interest rate and assets serving as collateral vary by tranche. Wealthy investors such as pension funds and financial institutions comprise the typical buyers. 

Smaller buildings and businesses may not qualify for this financing option, as the minimum loan amount is usually $2 million. Although the length of these loans is similar to term loans at 5, 7 or 10 years, the loan amount is actually amortized over 25 to 30 years like a home mortgage. A master loan servicer and a primary servicer also replace the lender. The primary servicer is who you pay and who you contact with questions regarding your loan.

Advantages of CMBS loans

A major advantage of CMBS loans is the longer amortization period, which reduces your mortgage payments. This may allow you to better manage cash flow when cash is tight. If you want to pay the loan off faster, you can make additional principal payments.

Another big advantage is that the apportioning of risk through securitization often reduces the interest rate. Your rate for a CMBS loan will often be lower than it would be for a traditional, portfolio-held commercial mortgage.

Disadvantages of CMBS loans

A primary drawback of this mortgage funding option is that loan securitization translates into less loan flexibility and more rigid terms. While this may be of minor concern initially, it could lead to problems later on if your business experiences payment issues. If you encounter financial difficulty, it will be much more difficult to work out a solution that doesn't involve legal action. 

Why is this the case? When the loan is securitized, it is typically pooled in a trust managed by a master servicer. If you need to restructure your loan, there are tens of hundreds of investor-owners who are parties to this trust, instead of a single owner. The master servicer who organizes your loan in place of that owner has a fiduciary duty to the trust. The effort required to adjust your loan may run counter to that duty.

When to use a CMBS loan

Lower loan and mortgage payments can help you purchase a property when your company is in rapid growth mode, experiencing short-term payment delays or encountering other instances where business is healthy but cash is tight. CMBS loans can also be used as part of a multi-source funding strategy. For example, in an acquisition, you could use CMBS loans to purchase property and term loans to purchase equipment and other assets. If you intend to refinance or sell your building within 5 to 10 years, a CMBS loan is a practical choice.

CMBS loans are a viable commercial real estate financing option if your building and needs fit the parameters. Your banker can help you determine how to use this type of loan as a component of an integrated strategic approach that reflects your business' long-term goals.

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This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.