CMBS Loan Assumption: What Investors Need to Know
CMBS loans are generally fully assumable pursuant to lender approval and a small fee. Fees vary by lender and servicer but are typically around 1% of the UPB (unpaid principal balance) of the loan. This fee will typically be paid by the new borrower, though this can be negotiated during the sale process. CMBS loan assumption can be of significant benefit to both the seller of a property and a new borrower, but it isn’t a good idea in all situations.
CMBS Loan Assumption Benefits for Property Sellers
If you’re looking to sell your property before your loan reaches its maturity date, you’ll generally be required to pay a potentially hefty prepayment penalty. This typically comes in the form of yield maintenance or defeasance. Yield maintenance prepayment penalties require the borrower to ensure the lender receives the same yield as if the borrower had paid all the interest payments up to the loan’s maturity date.
Therefore, avoiding loan prepayment fees is perhaps the main benefit of loan assumption for property sellers. In addition, if the loan terms are good and there is still a large LTV ratio on the loan, the possibility of loan assumption may attract more buyers to the property, allowing the seller to close faster and for a potentially higher price.
CMBS Prepayment Fees Explained
As previously mentioned, the two main types of CMBS prepayment fees are yield maintenance and defeasance. Yield maintenance penalties are calculated by taking the difference between the interest rate of the loan and the current market interest rate for the current UPB (unpaid principal balance) of the loan. This means that yield maintenance can become quite expensive if interest rates have fallen significantly during the life of the loan.
For example, if interest rates had fallen from 5% to 4%, and a loan had a UPB of $1 million and 3 years of the remaining term, the borrower would have to pay the difference between these interest rates (1%) of the loan’s remaining balance, plus additional fees. That example is an oversimplification, as calculations for yield maintenance can get complex and are best done using a specific yield maintenance calculator or an excel sheet. Sometimes, a yield maintenance expert may be required to take care of the process for the borrower.
The specific formula for yield maintenance is:
Yield Maintenance = Present Value of Remaining Payments on the Mortgage x (Interest Rate - Treasury Yield)
In contrast, defeasance involves substituting the collateral of the loan with bonds, generally U.S. Treasury bonds, in order to guarantee the CMBS investors the same return as if the borrower had not decided to repay the loan before the maturity date. Defeasance is generally more expensive than yield maintenance when Treasury interest rates are low, as more bonds must be purchased to replace the investor’s income. This is referred to as a defeasance premium.
In comparison, defeasance is generally less expensive than yield maintenance when interest rates are higher, and sometimes, this may result in the borrower actually making money when they prepay the loan. This is referred to as a defeasance discount. Like yield maintenance, defeasance can be a complex process and generally must be handled by an experienced defeasance consulting firm, which will take care of calculating the exact collateral required, purchasing it, and placing it in a special type of escrow account that will send the required interest payments to the CMBS investors via the REMIC (real estate mortgage investment conduit) that contains the securitized loans. The firm, via the escrow account, will also repay the CMBS investors by releasing the bond collateral at the loan maturity date.
Sometimes, borrowers may be able to choose between defeasance and yield maintenance when prepaying their loan. This option may be negotiated during the loan origination process and varies based on the exact nature of the defeasance clause or yield maintenance clause contained within the loan contract.
CMBS Loan Assumption Pros and Cons for New Borrowers
For new borrowers, assuming an existing CMBS loan has a variety of benefits and drawbacks.
The pros of assuming a CMBS loan include:
Lower interest rates: If interest rates have risen during the existing life of the loan, the new borrower may be able to lock in a better interest rate than if they had gotten an entirely new CMBS loan.
Faster closing times: Since CMBS loan assumptions require far less paperwork than getting a new loan, conduit assumptions close faster than traditonal CMBS loan originations. In many cases, they close in 30 days or sooner. CMBS loan assumptions generally do not require a new appraisal or environmental reporting, but generally do require borrower net worth and credit score verification, and sometimes, property condition assessment (PCA).
Lower closing fees: Getting a new CMBS loan can be expensive due to origination fees and lender legal fees, which generally cost at least $15,000. CMBS loan assumption, as previously mentioned, does not require as many third-party reports, and assumption fees are generally close to 1%.
The cons of assuming a CMBS loan include:
Higher interest rates: If interest rates have fallen during the existing life of the loan, the new borrower may be able forced to pay a higher interest rate than if they had gotten an entirely new CMBS loan.
Higher down payment: Since the CMBS loan has already been partially paid off, the seller may have a lot of equity in the deal already. This means that the assuming borrower will get a loan at a lower LTV ratio, and therefore will need a larger down payment at closing.
Approval process complications: While most loan assumptions close faster than traditional originations, if the CMBS loan is complex, such as loans involving exotic properties or a portfolio of properties, the assumption process could actually take longer than getting a new loan.
Lender and servicer requirement: Since the current loan is already with a specific lender and servicer, the new borrower is required to work with the current servicer and borrower, even if they don’t have the best reputation.
Similar borrower qualifications: Just because a new borrower is assuming a loan doesn’t mean that they don’t need to have the same qualifications as if they were getting brand new financing. Credit scores, net worth requirements, and experience requirements are still examined, and a new borrower may not always be approved. Just like getting a new CMBS loan, assuming borrowers will generally need to have a net worth of at least 25% of the loan amount, between 5-10% liquidity, and a score of 660-680+.
Despite the Benefits, CMBS Assumption Isn’t Right for Everyone
Due to the potential cons of CMBS loan assumption, a new borrower shouldn’t count on being approved for, or even wanting to assume the current loan on a property. In addition, a CMBS loan may not be the best loan type for their individual situation. Therefore, borrowers looking at the loan assumption process should generally have a backup plan and be talking to other lenders, whether CMBS or otherwise, as they attempt to complete the property acquisition process.