Since 2007, CMBS bondholders have made and lost millions as servicers have managed through a torturous recession. Borrowers also felt the brunt of the laborious CMBS process as they tried to modify and restructure their debt. But while some parts of the country are still suffering, for the most part, the future is filled with maturities turning into new originations. One other less talked about structure is the assumption of CMBS loans as the threat of rate increases looms.
For the past 12 months, as the economy has continued to recover, CMBS loan assumptions have been on the rise. Our economy is back with long-term, low interest rates and increasingly competitive term sheets. Unlike the “old” days, CMBS assumptions can be just as complex as modifications. They require multiple levels of approval from master servicing, special servicing, controlling class representatives, and often rating agencies.
Within the newer securitizations, more often than not, another layer of approval may be required from a newly developed role: the operating advisor. And, just like the CMBS 2.0 vintage of originations, there are often additional requirements that come with loan assumptions. Some recent examples to watch out for:
• Newly required or increased reserves. While these are negotiable, additional capital expenditures, replacement reserves, and TI/LC for tenant rollover are required;
• Completion of any existing deferred maintenance. If identified in an annual inspection, these items may be required to be resolved by the seller prior to consent of the assumption;
• Additional fees. Servicers are requesting an assortment of fees, which are now considered to be “industry standard” even though they are not required in loan documents; and,
• Modifications. Many buyers are including modifications, such as partial releases, in order to gain more flexibility that was not provided in the past. Modifications can likely cost an additional basis point if approved.
CMBS is a great long-term, fixed rate debt structure, but it has limited flexibility that will continue into the future. Buyers who traditionally finance their activities with bank and/or life companies are often surprised when entering a CMBS loan assumption for the first time. All CMBS trusts (the entities that hold CMBS loans) are bound by very strict IRS guidelines in order to preserve the pass-through structure of all income flowing to various CMBS bondholders.
No master servicer wants to make an errant decision that could potentially disqualify an asset from enjoying pass-through tax benefits and thereby causing the trust income to be double taxed (similar to corporate dividends) at the CMBS trust level and then again at the individual bondholder level.
CMBS assumptions are a valuable vehicle offered in the marketplace to facilitate commercial real estate trades, but the process can present more challenges when compared to a typical bank or life company assumption. So ASSUME carefully.