In my role as a borrower advocate, I get the opportunity to work
directly with commercial real estate owners who have CMBS debt.
While they are generally savvy borrowers sometimes they get
tripped by certain myths.
Myth No. 1: I don’t need to worry about cash management springing on my loan if my property is performing. The general premise
of springing cash management is to allow the lender to capture all
cash flow in the event of declining property performance. As they
say though, the devil is in the details.
Typical current CMBS loan agreements include many definitions within definitions which the servicer uses to calculate DSCR
The bottom line is many
today with actual DSCR of 1. 5 and above are being put into cash
management only because the servicer is performing its own
calculation based on the specific details in the loan agreement
and are excluding certain income line items, adding other
expense items and using an amortizing payment.
Myth No. 2: I don’t need to worry about cash management because
my property is outperforming the market. Included in the details
of the servicer’s DSCR calculations, there is a term called
“Underwritten Operating Income.” This definition allows the servicer to adjust rental rates, occupancy rates, and other items to the
lower of actual, market or underwritten rates. So, if you have negotiated above-market rental rates and/or have above-market occupancy, you will not get the credit for that when calculating your
DSCR as it relates to cash management.
This really stings when the underwritten occupancy at origination of the loan was 80% and current occupancy is now at 90%.
With this definition in your loan agreement, income will always
be calculated assuming 80% occupancy—unless the market occupancy is below that, regardless of the actual occupancy.
Myth No. 3: When a buyer assumes an existing CMBS loan, the
terms will not change. Most buyers entering into an assumption of
an existing loan believe they will be assuming the terms of the loan
as written in the original loan documents, which is not entirely the
case. There are deal terms that cannot change, like interest rate
and maturity date. What is wide open to change, however, are:
Reserves: Servicers can add reserve requirements that aren’t in
the loan documents and they can increase the amount of reserves
as much as they feel warranted. Often, any caps in place on the
reserves are removed at the time of assumption.
Additional collateral: Sometimes the additional collateral is in
the form of a reserve, sometimes it is a letter of credit and sometimes it is in the form of a guarantee. The point is, the servicer can
ask for additional collateral for any number of reasons.
Cash management: If the loan has springing cash management,
you can bet that it will be sprung at the time of assumption, regardless of the property performance. Don’t be fooled into thinking the
buyer can request changes to the loan documents at the time of
assumption—the servicer will not entertain such requests.
Myth No. 4: If I am assuming an existing CMBS loan, the purchase
price doesn’t matter since the loan is in place. That used to be the
case. Now some special servicers are requiring a buyer to establish
a reserve to make the LTV equal to what it was at origination of the
loan. This one item impacts buyers’ IRR so severely that many back
out of deals when they learn of this requirement. For example, say
the property was appraised at origination for $25 million and the
borrower got a 65% LTV loan at that time. The loan would equal
$16.25 million. Fast forward a few years and the property is being
bought for $22 million, and let’s assume the loan is interest only, so
the total due was still $16.25 million. A 65% LTV loan on a property
value of $22 million would equal $14.3 million. Since the current
loan is $16.25 million, the difference between $16.25 million and
$14.3 million ($1.95 million) would be required in the form of a
collateral reserve at closing of the assumption. The $1.95 million
cannot be used to actually pay the loan down because CMBS loans
have prohibitions and/or penalties for paydowns. ◆
Four Myths About CMBS
That May Cost Borrowers
properties are being put into
cash management because the
servicer is performing its own
BY ANN HAMBLY
Ann Hambly is founder and CEO of 1st Service Solutions. She may be
contacted at email@example.com. The views expressed here are those of
the author and not ALM Real Estate Media or its publications.