A Commercial Mortgage Backed Security (CMBS) loan is a fixed-income security backed by a commercial mortgage. Sometimes referred to as a conduit loan, these loans are for commercial property types such as malls, apartments, office buildings and factories.

A CMBS is created when a financial institution groups all its commercial loans, then sells them in securitized form as a series of bonds. Each of the series of bonds is put together to create segments, with each segment characterized by the level of risk attached to it. They are organized from low-risk and low-yield to high-risk and high-return. The low-risk segments are first to get paid the principal and interest, while the high-risk segment is the last to be paid should the debtors' default.

CMBS loans are commercial and multifamily real estate loans that are pooled into securities and sold to investors on the secondary market. CMBS stands for commercial mortgage backed security. These securities may consist of loans for properties such as hotels, apartment buildings, office buildings, hospitals, or other types of income-producing commercial real estate assets. Unlike HUD 223(f) loans, which are fully amortizing loans with 35-year terms, most CMBS loans are partially amortizing and have 5,7, or 10-year terms. This means that borrowers will either have to refinance the loan or pay a hefty balloon payment at the end of the loan’s term.

In general, CMBS loans are much easier to get approved for than HUD 223(f) loans. Unlike 223(f) loans, which require a borrower to have a strong financial history and great credit, CMBS loans are asset based, which means that as long as the property hits the right LTV and DSCR requirements, it will usually be approved for a loan.

While extended closing times can be an issue for certain borrowers, it’s important to understand that the HUD 223(f) program offers longer terms and longer amortization at a lower interest rate than CMBS loans, Fannie Mae, Freddie Mac, and life company multifamily loans. For instance, Freddie Mac Fixed-Rate Conventional Loans, which start at $5 million, only offer up to 30-year fixed-rate loan terms, while Freddie Mac Small Balance Loans, which start at $750,000, only offer up to 10-year fixed-rate loan terms and up to 20-year adjustable-rate terms. Both loans offer a maximum of 80% LTV, noticeably less than HUD 223(f) loans.

Fannie Mae DUS loans, which start at $3 million, are somewhat similar to Freddie Mac, in the sense that they offer up to 30-year loans with up to 30-year amortizations, with LTVs up to 80%. Fannie Mae Small Loans, which start at $750,000, offer the same. While many Freddie Mac and Fannie Mae loans do offer fully amortizing options, this doesn’t always mean that a borrower will be approved for it.

CMBS loans rarely have fixed-rate loan terms of over 10 years, with 15 years usually being the maximum (and only done in special situations). This means that a property sale or refinancing will typically always be required at the end of the loan term, which can be expensive and inconvenient for investors who wish to hold onto a property for more than 10 years. Of course, CMBS financing is generally much easier to get approved for than HUD/FHA multifamily loans (or Fannie Mae/Freddie Mac loans), as it generally focuses on the financial strength of the real estate asset itself and less on borrower history and financials.

CMBS loans offer several advantages for commercial real estate financing, including:

• Flexible underwriting guidelines (apartment.loans/posts/cmbs-explained)
• Fixed-rate financing (apartment.loans/posts/cmbs-explained)
• Fully assumable (apartment.loans/posts/cmbs-explained)
• Lenders and bondholders can potentially achieve a higher yield on investments (apartment.loans/posts/cmbs-explained)
• Investors can choose which tranche to purchase, allowing them to work within their own risk profiles (apartment.loans/posts/cmbs-explained)
• Low interest rate financing (cmbs.loans/blog/cmbs-loans-pros-and-cons)
• Underwritten on the financial strength of the asset held as collateral (www.commercialrealestate.loans/how-to-get-a-commercial-real-estate-loan)
• Terms of five to 10 years, with amortization periods of up to 30 years (www.commercialrealestate.loans/how-to-get-a-commercial-real-estate-loan)

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.

To obtain a HUD 223(f) loan, borrowers must be a single asset, special purpose entity (SPE), which can either be a for profit or a non-profit entity. Additionally, the loan must be for a minimum of $1 million, have a minimum loan term of 10 years, and a maximum term of 35 years (or 75% of the property's remaining economic life). Leverage requirements vary depending on the type of property, with market rate properties requiring 83.3% LTV, affordable properties requiring 85% LTV, and rental assistance properties requiring 87% LTV (90% LTV for properties with 90% or more rental assistance). Interest rates are fixed, terms range from 4.10% to 4.75% (including MIP), as of Jan. 2019. DSCR requirements also vary depending on the type of property, with market rate properties requiring 1.17x minimum DSCR, affordable properties requiring 1.15x minimum DSCR, and rental assistance properties requiring 1.11x minimum DSCR. There is a 1% upfront mortgage insurance premium for all property types, then, annual MIP of 0.65% for market rate properties, 0.45% for affordable properties, and 0.25% for Energy Star SEDI certified properties. There is also an FHA application fee of 0.30% of the total loan amount. Cash out is allowed under specific conditions, with LTV must be at least 80% (including transaction costs in the loan amount). Repairs are limited to $6,500/unit (more in high-cost areas), or 15% of the property value, or 20% of the mortgage, with no more than half of any essential structural component (e.g. roofing, HVAC) may be replaced. Properties must also be at least three years old (for new properties), or have had the last substantial renovation three years ago or more (for renovated properties), and the owner/developer must place funds monthly in a replacement reserve account.