Non-Recourse, High-Leverage Apartment Financing for Multifamily Investors

While Fannie Mae, Freddie Mac and HUD apartment loans generally provide the lowest-cost financing available on the market today, they aren't ideal for everyone. For one, high net worth and liquidity requirements may prove a barrier for entry for many investors. In addition, HUD and agency loans are generally only available for strictly multifamily properties (typically with a small commercial component allowed), while mixed-use properties with a heavy commercial component usually do not qualify. For investors in either scenario, CMBS loans, also referred to as conduit loans, may be an ideal solution.

In addition to being a good choice for borrowers with a lower net worth or those looking to finance mixed-use properties, CMBS loans can also be an excellent choice for borrowers with credit or legal issues. As CMBS financing is generally asset-based, lenders are not as concerned with borrower qualifications and are typically more interested in the financial stability of the property itself.

How CMBS Loans Work

Unlike some other types of apartment financing, CMBS loans are securitized (pooled into a large group of CMBS loans) and are then sold to investors on the secondary market. This is good for lenders, who can, for the most part, wipe their hands clean of the risk associated with holding the loan. However, this can make things complicated for borrowers. Because conduit loans are packaged together and sold to investors, they're not serviced by the lender that initially issued them. Instead they're serviced by a third-party firm, usually referred to as a Master Servicer. These firms have a reputation for inflexibility and may not be willing to offer loan modifications (as a bank or agency lender occasionally might) in the case of financial hardship.

Traditionally, if a CMBS loan goes into default, the Master Servicer will actually send the loan to be serviced by a different company, a Special Servicer. The Special Servicer will determine whether the loan can be reasonably modified or whether they should initiate foreclosure proceedings on behalf of investors.

CMBS Prepayments, Property Types and Subordinate Debt

CMBS apartment financing is generally available in the form of 10-year fixed-rate loans, though other types of conduit loans exist, albeit more rarely. When it comes to paying off a CMBS loan early, borrowers can generally choose between yield maintenance and defeasance. Yield maintenance requires borrowers to pay the lender (or in this case the investors) the same yield as if the borrower was making all the loan's scheduled payments. In contrast defeasance requires the borrower to replace the loan's collateral with a sufficient amount of comparable, income-producing securities (often U.S. Treasuries).

CMBS Apartment Loan Terms

• Loan Size: Generally $2 million+
• Loan Term: Typically a 10-year fixed-rate loan (though other term lengths may be available)
• Amortization: 20-30 years
• Pricing: Starting at 200bps over the relative swap rate or Treasury
• Amortization: 25-30 years
• Leverage: 75% Maximum LTV
• DSCR: Minimum 1.25x DSCR
• Debt Yield: Minimum 6.5% DY
• Recourse: Loans are generally non-recourse with standard “bad boy” carve-outs
• Reserves: Insurance, taxes, leasing costs and replacement reserves are often required, though this varies on a deal-by-deal basis.
• Prepayment: Yield maintenance or defeasance

Advantages:

• Competitive interest rates.
• Loans are non-recourse.
• High leverage; typically up to 75% LTV.
• Flexible loan sizes.
• May be ideal for borrowers with mild credit or legal issues.
• Qualified borrowers often have the option of adding mezzanine debt or preferred equity to their capital stack to increase leverage.
• CMBS loans are generally fully assumable.
• Cash-out refinancing available.

Disadvantages:

• Loans can be pricey to exit.
• Loans will not be serviced by the borrower's original lender.
• Borrowers may face restrictions as to how they operate their property.
• One to two-year lock-outs may prevent prepayment.