Where do CMBS Loans Make Sense?

For owners of hotels, this might be the right time to refinance your assets through a commercial mortgage-backed securities, or CMBS, loan. CMBS isn’t the right refinancing vehicle for every situation, but it can provide some benefits to the borrower not available from other financing sources.

The climate for CMBS has improved considerably since the end of the recession. When lenders first returned to the market they were looking at deals north of $25 million or $30 million with debt yields starting at 15%. Cash-flow coverage requirements were high and loan-to-value ratios were low. But as the industry improved and hotel RevPAR and profitability grew, there has been increased investment in hotel real estate , including from CMBS sources.

Leverages began to increase, cash flow coverage requirements went down, debt yields lowered and interest rates have stayed low. Since we’ve come out of the recession values have increased and CMBS has been a very attractive vehicle for hoteliers to tap into their equity by refinancing out of higher-rated debt.

However, in recent months, as the CMBS market continues to heat up, some properties with flags from secondary brands and located in secondary or tertiary markets have been getting some pushback with higher leverage requirements.

But CMBS remains a very attractive low cost form of equity. It’s a great vehicle for a long-term play in which a owner has a hotel asset and is able to put a 10-year note on it at a very attractive interest rate. By recapitalizing their assets, owners can take out some of the equity they’ve built up over years of operation.  The loans are non-recourse which limits contingent liability and provides balance sheet flexibility for future hotel developments.

It’s not the right vehicle for someone who just built a new hotel and is trying to stabilize it or is looking for a bridge-type loan. It’s truly best for an existing cash-flowing asset that you want to put to rest for a number of years and access your capital at a lower your interest rate.

The long-term aspect of CMBS loans should be a key consideration for potential borrowers. It’s not a vehicle built for flexibility. It’s a fixed-rate, five- to 10-year note. CMBS lenders pool these loans into securities in which the hotel real estate is used as collateral.

Typically, hotels represent 10% to 15% of a CMBS pool. Investors are guaranteed a coupon with a specific return for the five- to 10-year life of the loan, As a result, it’s difficult for the borrower to pre-pay the loan before maturity.  These defeasance clauses require the borrower to pay the income due to the investors for the remaining life of the loan. As such, it can be very costly to get out of the deal before maturity.

Three considerations are part of the mechanics of underwriting a CMBS loan. You have LTV, debt yield and cash-flow coverages. A lender looks at all three of the factors in determining how they want to price the loan and how they want to structure it.

Typically, preparing an application for a CMBS loan is similar to the process for other types of loan applications. However, there are some nuances. For instance, while a bank loan application might be more concerned with the borrower’s personal finances, a CMBS originator will probably look more closely at the asset to be used as collateral. It’s wise to use an intermediary such as Premier Capital Associates who has experience in the CMBS environment to help you create a loan package that meets the criteria for this type of financing and addresses issues important to you.

We have strong relationships with lending sources so they have confidence that when we bring them a transaction it is a good transaction that makes sense and is something they can lend on and be willing to spend the time looking at.

While the hotel industry and its fundamentals are forecast to remain strong through this year and beyond, it might be the right time to pull the trigger on a CMBS loan. Underwriters get concerned when things are too good, and when there are too many years of consecutive RevPAR growth and other positive fundamentals, they might decide to step back.

Another consideration is what the Federal Reserve Bank will do with interest rates. They have basically stopped their quantitative easing program and they are letting the market absorb that. There has been potential talk about the Fed raising the interest rate by 50 basis points in mid-year when they meet again.

We can’t stay at these artificially low interest rates forever because people need to be able to get a return. How the Fed handles this situation is critical. A half-point increase might jolt the market a little bit, equity markets will get kicked in the teeth a little bit, but ultimately it will be absorbed.

I just don’t want the Fed to raise the rates by a point or more so it shocks the market and produces unwanted fall out.

It’s the right situation to look at your portfolio and consider a CMBS loan now. There will likely be some upward pressure on rates throughout the balance of the year.