• What is a Real Estate Mortgage Investment Conduit?
• CMBS loans typically have a five-year lockout clause
• CMBS loans typically have a prepayment penalty or Defeasance fee.
• Conduit lenders all require huge impounds that must be funded monthly
• Second mortgages are forbidden on CMBS loans (without permission)
• Conduits Forbid Improvements on Commercial Property

Conduit
The financial intermediary that sponsors the conduit between the lender(s) originating loans and the ultimate investor. The conduit makes or purchases loans from third party correspondents under standardized terms, underwriting and documents and then, when sufficient volume has been obtained, pools the loans for sale to investors in the CMBS market.


Conduit Lenders
Commercial real estate loans that are originated for the CMBS market (Commercial Mortgage Backed Securities) are known as CMBS loans, and the mortgage bankers, investment banks, and commercial banks that originate CMBS loans are traditionally known as conduits.


Real Estate Mortgage Investment Conduit (REMIC)
A conduit is short for a REMIC (Real Estate Mortgage Investment Conduit). Mortgage bankers or investment banks that originate commercial mortgages that go into the REMIC's are now called conduits or conduit lenders.

A REMIC is a Trust (a business entity formed to invest in real estate, mortgages and/or securities backed by real estate) and the conduit through which securitized commercial mortgages now pass tax-free.

Thanks to a vehicle, created by the Tax Reform Act of 1986, which permits the sale of interests in mortgage loans in the secondary market. It is a pass-through entity that can hold loans secured by real property and issue multiple classes or investors without the regulatory, accounting and economic obstacles inherent with other forms of mortgage-backed securities; referred to as REMIC similar to a Real Estate Investment Trust (REIT) that is required to pass through 95% of taxable income to their investors and are not taxed at the corporate level.


CMBS loans have long-term, fixed interest rates. These loans are typically quoted as some small margin or spread over either 10-year Treasury bonds or swap spreads.


CMBS loans typically have a five-year lockout clause that prohibits an early prepayment. Followed by the lockout period is the prepayment penalty term that keeps you from paying off your commercial mortgage loan prior to full term...called a Defeasance fee.


Prepayment Lockout
The number of periods during which the borrower is restricted from prepaying the mortgage loan; typically expressed in years or months. In order to reduce prepayment risk, commercial mortgages commonly have lockout periods and/or prepayment premiums or yield maintenance.

A prepayment penalty is paid by the borrower for any prepayments made on a mortgage loan if required under the loan documents. The premium is usually set at a fixed rate which, at times, decrease in steps as the loan matures.

For example, a mortgage loan can have a premium of 5% for the first seven years and during the next five years the premium decreases at a rate of 1% per year (4% in year eight, 3% in year nine); after year twelve, there is no prepayment premium.

A good rule of thumb when paying off a loan with a defeasance prepayment penalty is that you will have to pay an extra 2% per year for each of the remaining years of the loan.



CMBS Loans All Require Monthly Impounds
An impound is an extra sum that must be included with the normal principal and interest payment every month.

Similar to Residential home loans whereby the lender collects taxes and insurance on top of the principle. Commercial Impounds also include real estate taxes and insurance plus Reserves that are held like a savings acount.


Replacement Reserves
Replacement reserves are various account(s) maintained (typically by the Lender) to provide funds for anticipated expenditures required to maintain a building.

A reserve account usually is required by a lender in the form of an escrow to pay upcoming taxes and insurance costs.

A replacement reserve is usually an amount set aside from net operating income to pay for the eventual wearing out of short–lived assets; monthly deposits that a lender may require a borrower to a reserve in an account, along with principal and interest payments for future capital improvements of major building systems (e.g. HVAC, parking lot, carpets, roof, etc.). Replacement reserves are typically calculated on a per unit basis (e.g. multifamily - per unit; office, retail, industrial - per square foot; etc.).


Tenant Improvements
Improvements or renovations (expense to physically improve) made to the property to attract new tenants to new or vacated space which may include new improvements or remodeling (build special walls, to install special plumbing and other fixtures, and to paint and re-carpet the unit). May be paid by tenant, landlord or both. Typically, tenants are provided with a market rate TI allowance ($/sq. ft.) that the owner will contribute towards improvements.

Amounts above the TI allowance that the tenant wants must be paid for by the tenant.
(see commercial mortgage glossary for TI)


Tenant Improvement Costs-Renewed (re-tenanting) (TIs)... A fee paid by the property owner or the tenant to a real estate broker or leasing agent for services rendered; typically paid by a property owner at the time of a lease renewal.

Usually calculated as a percentage (1% to 6%) of the entire lease payments, paid in increments during the lease term.


CMBS Lenders Forbid Second Mortgages (see mezzanine loans for solutions)


Conduits Forbid Improvements on Commercial Property
You cannot make any structural changes to the property when the trust documents forbid structural changes to the property. Because of tax laws, the Commercial Mortgage Backed Security (CMBS) is a bond secured by a pool of mortgages that someone owns.

Mortgages Pools generate millions of dollars in monthly interest income. If a corporation or a limited liability company owned this pool of mortgages, they would pay millions of dollars in taxes on that income, and then the bondholders suffer double taxation when they get their interest checks by having to pay taxes a second time on that income.

The Federal government created an exemption for passive trusts to stimulate the growth of an organized market for commercial mortgages, that merely hold the mortgages for the bondholders. If the trust remains passive and does not actively participate in the management of these pools of mortgage, the trust maintains their tax-free status, and avoids paying millions of dollars in taxes that are generated by these pools of commercial mortgages.


Therefore, when an investor accepts a loan from a conduit, he is giving up his right to make any structural changes to the property.... unless the investor negotiates the right to make specified structural changes before the loan closes. Once the loan closes, it is too late to go back and amend the documents.



Interest-Only Conduit Loans
Conduit Lenders are offering commercial loans with no amortization. Typically, commercial mortgage loans are amortized over 25 years. The norm for conduit lenders financing commercial property older than 25 years old, was to fianance the property with a smaller loan amount on a 20 year amortization schedule (increasing the monthly payment).


Conduit lenders then began to offer interest-only for the first year (amortized over 25 years). Then interest-only for two years and now three and four year interest free mortgages are becomming the norm (still amortized over 25 years).




MTG Brokers insist on commercial mortgage loans made with no points, no prepayment penalty, and no required impounds.


Click Here To Find if You Qualify for no points, no prepayment penalty, no impounds, no reserves, and no prohibition against a reasonable amount of junior financing.