The benefits of a commercial mortgage-backed securities loan make it difficult to turn down, but there are downsides as well.
Commercial mortgage-backed securities (CMBS) loans are fantastic, except for when they aren’t.
The hospitality capital markets for debt financing are dominated primarily by two financing types: bank loans and CMBS loans. Each financing type plays a role in the market, but CMBS loans tend to dominate the volume rankings because of leverage. For hotel owners that want to lever up, there is no pool of capital as accessible and advantageous as the conduit market is. Thus, the hotel debt environment is tiered between borrowers with flexible, low-leverage, fully-recourse bank loans and borrowers with inflexible, high-leverage, non-recourse CMBS loans.
This has impacts beyond the capital markets, and it’s why CMBS loans are like golden handcuffs.
Conduit loans are a tradeoff. Leaving interest rates aside, since both CMBS and bank loans are currently competitive, CMBS offers benefits to owners that are hard to turn down. High leverage loans that are non-recourse allow owners to capitalize projects with less equity, permitting deal flow to continue. And, since the deals are non-recourse, risk taking can progress unfettered.
But with these unbeatable features come the downsides. Closing a CMBS loan is expensive and time-consuming. Once a loan closes, borrowers are burdened with inflexible servicers and rigid loan documents, often restricting an owner’s ability to operate their hotel in a sensible and logical manner. Springing cash management, DSCR (debt-service coverage ratio) tests, trigger periods, seasonality reserves, PIP (property improvement plan) reserves and other generally disliked features are the norm, not the exception.
This is a problem because the benefits of CMBS still typically outweigh these negatives, leaving borrowers stuck. This is a short-term snapshot of a market in flux.
Although borrowers understand that CMBS still currently offers them something hard to turn down, hotel owner sentiment towards CMBS has evolved and will continue to shift towards other capital sources unless CMBS improves. Over time, if this sentiment shift goes too far, bond buyers will be left with no loans to buy and rating agencies with no loans to rate.
These market participants should take the long view. Rather than forcing restrictions on borrowers so that each transaction is excessively structured to benefit the lender, terms should ease up so there will be a high-volume market in the future. There is no market without happy, repeat borrowers.
Recognizing these phenomena, some conduit lenders have started to structure deals more advantageously for borrowers. Upon request, and only with intelligent negotiation, borrowers can obtain CMBS loans with terms that are less onerous than they normally would be. But this requires knowing everything that is and isn’t negotiable, and most borrowers are focused on running their hotels and not the minutia of loan documents.
Because upfront negotiating can save a borrower from being locked in with golden handcuffs, it’s worth going into a CMBS loan closing with the necessary effort expectations, knowledge, goals and team. Keep the gold; lose the handcuffs.
Zak Selbert is the founder and Chief Executive Officer at Vista Capital Company. Vista is a boutique real estate investment banking firm that specializes in arranging financing for hotels. Mr. Selbert can be contacted at 310-285-3803 or email@example.com.
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