In times of business disruptions, such as vacancies in apartment buildings and offices, the number of defaults on commercial mortgages and leases tends to increase significantly – impacting various industries, including hotels and retail stores. For example, in September 2023, 88.9% of CMBs office property loans defaulted upon maturity totaling $672M, while 11.1% were paid off.[1] This marked the highest monthly default rate and dollar amount for the year, surpassing the previous peak in April when 51.1% defaulted, totaling $167.2M.[2]
What is a CMBS Loan?
First, let’s start with the basics. What is a CMBS loan? A Commercial Mortgage-Backed Security loan, aka CMBS loan, is a type of commercial real estate financing where lenders bundle commercial mortgage loans together, transfer them into a real estate mortgage investment conduit (REMIC) trust, and sell them as a series of bonds.[3] Because banks do not carry CMBS loans on their financial statements, they are able to provide these loans to borrowers at relatively low fixed interest rates and offer borrowers relatively high levels of leverage. Additionally, most CMBS loans are nonrecourse, which means the lender’s only remedy is to foreclose on the property and take possession of it.
How Can Borrowers Acquire CMBS Loans?
CMBS loans are offered for income-generating properties, including multifamily units, self-storage facilities, hotels, industrial structures, retail spaces, and office buildings.[4] To qualify for a conduit loan, applicants need to request a minimum loan amount of $2 million and seek a maximum leverage of 75% or less. Furthermore, borrowers with a lower net worth or those looking to finance mixed-use properties can also consider CMBS loans. These loans are particularly appealing for investors with credit or legal challenges, as lenders prioritize the financial stability of the property itself.
How Can Investors Acquire CMBS Loans?
Retail investors interested in CMBS debt have several options to consider, as they can invest directly or explore investment opportunities through mutual funds and specialized exchange-traded funds (ETFs) that are centered around mortgage-backed securities.[5] By purchasing shares in these dedicated ETFs, smaller investors gain the opportunity to access the stable fixed income returns offered by CMBS loans while simultaneously spreading risk through diversification.
Within the realm of ETFs, there are options also tailored to concentrate on mortgage-backed securities (MBS), which are primarily composed of residential mortgages but may also encompass commercial mortgage-backed securities. These MBS-focused ETFs provide an attractive avenue for retail investors seeking to venture into debt securities. They serve as a means to diversify risk without necessitating a substantial initial investment.
How Does a CMBS Bond Compensate an Investor?
Investors select specific CMBS bonds based on their desired level of credit risk, yield, and duration.[6] Each month, the interest payments from the pool of loans are distributed to investors, starting with those investors holding the highest-rated bonds. This process continues until all accrued interest on those bonds is fully paid. Subsequently, interest is distributed to the holders of the next highest-rated bonds and so forth. This payment sequence is commonly known as the "waterfall." In situations where there is a deficiency in the contractual loan payments from the borrowers or if the loan collateral is liquidated but fails to generate sufficient proceeds to meet the payment obligations for all bond classes, investors in the most subordinate bond class will experience a loss. Any additional losses will then impact more senior classes in reverse order of priority.
It is important to be aware of your options with regards to CMBS loans and bonds. KI Legal’s transactional attorneys are well versed in these matters and are prepared to help guide you through the process. For more information on CMBS loans and bonds, or for help with your particular transactional matter at hand, contact us at (212) 404-8644 or email info@kilegal.com to discuss.
This information is the most up to date news available as of the date posted. Please be advised that any information posted on the KI Legal Blog or Social Channels is being supplied for informational purposes only and is subject to change at any time. For more information, and clarity surrounding your individual organization or current situation, contact a member of the KI Legal team.
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[2] Id.