What is Conduit Financing?
In apartment property investing, conduit financing typically refers to the use of conduit loans - also known as cmbs loans - to finance the acquisition of an apartment property.
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In the context of apartment property investing, conduit financing typically refers to the use of conduit loans - also known as CMBS loans - to finance the acquisition of an apartment asset. Much like with the general definition of conduit financing, cmbs loans involve the use of securitized, fixed-income investments, with the caveat that commercial real estate loans are used as collateral.
The collateralized loans are used to finance commercial properties such as residential apartment buildings, before being bundled together in a group of similar commercial mortgage loans. These larger groups are then packaged to be sold on a secondary market as secured bonds, categorized in what are known as tranches, organized by the level of risk involved.
Conduit Loans
Conduit financing is a good choice for borrowers with a lower net worth or who are looking to finance mixed-use properties. CMBS loans are also a great option for investors with credit or legal issues. Since CMBS financing is generally asset-focused, lenders are not as strict with borrower credit requirements and are more interested in the financial stability of the asset itself.
CMBS apartment loans are generally available with 10-year fixed-rate terms. Most of the time, they are non-recourse, and have a maximum LTV of 75%. In terms of prepayment, conduit loans often allow for defeasance, though yield maintenance can be an option in some cases.
Sample Apartment Conduit Financing Terms
- Loan Size: $2 million+
- Loan Term: Typically a 10-year fixed-rate (though other term lengths may be available)
- Amortization: 20-30 year
- Leverage: 75% Maximum LTV
- DSCR: Minimum 1.25x DSCR
- Debt Yield: Minimum 6.5% DY
- Recourse: Generally non-recourse with standard “bad boy” carve-outs
- Prepayment: Defeasance or yield maintenance
Related Questions
What is the difference between conduit financing and traditional commercial real estate loans?
The main difference between conduit financing and traditional commercial real estate loans is the underwriting guidelines. Traditional loans place great scrutiny on borrowers, often times limiting what is possible. CMBS loans, on the other hand, are readily available to new commercial property investors. Investors that cannot meet the strict conventional liquidity and possible net worth minimums can opt for a CMBS loan and receive the funding they need without all the red tape — quite often with superior rates and terms.
CMBS loans are generally available with 10-year fixed-rate terms. Most of the time, they are non-recourse, and have a maximum LTV of 75%. In terms of prepayment, conduit loans often allow for defeasance, though yield maintenance can be an option in some cases.
Pooling together single loans makes them more attractive to investors. It also allows investors to enter the commercial mortgage market. This increases the amount of available funding for commercial mortgage loans, and forces mortgage loans to be aggressively priced.
What are the advantages of conduit financing for apartment loans?
The advantages of conduit financing for apartment loans include:
- Lower net worth requirements for borrowers
- Asset-focused financing, allowing for more lenient credit requirements
- 10-year fixed-rate terms
- Non-recourse financing
- Maximum LTV of 75%
- Defeasance or yield maintenance prepayment options
What are the requirements for obtaining a conduit loan?
Conduit lenders typically require borrowers to have a minimum net worth and a minimum debt service coverage ratio (DSCR). The maximum loan-to-value (LTV) ratio is usually 75%, and the loan term is usually a 10-year fixed-rate. Prepayment options are generally defeasance or yield maintenance.
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What are the risks associated with conduit financing?
The risks associated with conduit financing include not getting a great servicing experience, as CMBS lenders don't service these loans themselves and hire a third-party servicer instead. Additionally, since these loans are pooled, securitized, and sold on the secondary market, borrowers are usually required to conduct either yield maintenance or defeasance in order to repay their loan. Furthermore, since these loans are securitized, borrowers who have trouble repaying their loans are unlikely to get any form of forbearance or foreclosure/default prevention assistance. Instead, if the borrower cannot make their monthly payments, they will likely default on the loan relatively quickly.
What are the typical terms of a conduit loan?
The typical terms of a conduit loan include a loan size of $2 million minimum, no maximum; 5-10 year fixed-rate terms with amortizations of 25-30 years; leverage of 75% maximum LTV/1.20-1.35x DSCR; pricing typically based on LTV and DSCR; assumability with a fee; prepayment penalties of defeasance or yield maintenance; and non-recourse with standard bad-boy carveouts. Appraisals are also required and paid for by the borrower.
Source: CMBS and Conduit Loan Terms
Source: What is Conduit Financing?