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Commercial Mortgage-Backed Securities (CMBS)

What is a commercial mortgage-backed security (CMBS)?

Commercial mortgage-backed securities are often referred to as conduct loans in the real estate industry and are a type of commercial real estate loan that offers high leverage loans that are secured by a first-position mortgage with low financing costs.

How commercial mortgage-backed securities loans work?

Commercial mortgage-backed securities loans are a combination of numerous mortgage loans bundled into a security which is then sold to numerous investors. The investors accept the risk that each loan comes with in return for a suitable interest rate. This process of combining numerous mortgage loans into a security is called the securitization process.

Master server

After future funds are processed through the master server / commercial mortgage server, the borrower will then receive the actual funds from the lender. The lender will then hold onto a small percentage of the funds to decrease their risk exposure. The master server will contact the borrower when needed to efficiently manage the loan throughout its term.

Benefits

  • Low interest rates
  • Fixed interest rates
  • Nonrecourse

Prepayment penalties

Yield maintenance is used by lenders as a prepayment penalty. This guarantees the lender all the scheduled interest payments. Lenders issue yield maintenance to safeguard the loan’s expected return on investment. This is seen as a safeguard as the yield maintenance places the responsibility of lost income from interest on the borrower.

Types of prepayment penalties:

Yield maintenance

The fee charged when paying off the outstanding balance of a loan during the yield maintenance period. The prepayment fee depends on the treasury yield but will typically range from 1 to 3% of the loan’s present value. Their note is then canceled but the loan is considered paid off.

Yield maintenance formula

Yield Maintenance = Present Value of Remaining Balance * (Interest Rate – Treasury Yield)

Defeasance

This prepayment option allows the borrower to exchange the property currently being financed for another cash-flowing asset with the original collateral still in place.

How can investors avoid the yield maintenance fee?

If the investor pays off the loan after the agreed upon yield maintenance period, the investor will not be charged any prepayment fees.