by RUSHI SHAH
Commercial Mortgage Backed Securities (CMBS) have been the backbone of the commercial real estate finance industry for the better part of the past 30 years. Even those who refer to CMBS loans as “golden handcuffs” recognize the critical liquidity they bring to the commercial real estate markets. While there may be other options available that some would say outrank CMBS in certain areas, there are also no free lunches. For example, a loan through life insurance companies or large balance sheet lender may appear more appealing for a borrower when it comes to servicing. If a hotel owner needs a high-leverage loan on a hotel property, however, they must look elsewhere, as it is prohibited for most of those providers.
In recent years, life insurance companies writing loans out of their own origination capital buckets have quickly learned that the most efficient way to be exposed to commercial real estate risk in their general accounts – the account from which investments are made from the received monthly premiums and from which all claims are written – is by actually investing in the primary markets via buying CBMS bond. These primary markets are also known as the new issue of CMBS bonds. Insurance companies use this investment mechanism to avoid overhead and save on the servicing and originations costs of running their own lending operation. Having a permanent supply of this type of capital has made the CMBS market highly resilient in more recent years, with annual volume for CMBS loans originated hovering between $60 billion and $100 billion. And 2020 origination volume fell on the lower end of this spectrum; for a short period, the CMBS market was completely stalled. Faced with the uncertainty of how long the pandemic would affect hotel demand, CMBS lenders adopted a wait-and-see approach for hotel financing.
Because of the forward-looking nature of capital markets, combined with the positive vaccine news, there is now a widespread expectation that hotels will make a comeback. The hopeful outlook for CMBS is evident in the risk-on appetite shown by the CMBS aggregators and the B-piece buyers. In the first quarter of 2021, lenders got back in the game and started to review new CMBS loan requests for both acquisitions and refinances. Many have even allowed modest cash outs at 60% to 65% loan-to-values. Rating agencies have also issued new guidance for underwriting CMBS hotel loans that use 2019 revenues for the property and its comp set revenues as starting points. On the expense ratio side, their guidance suggests comparing 2019 and 2020 metrics and using the worst of the two years to devise under-writable net operating income. For the most part, lenders aren’t looking at 2020 cashflow, unless it outperformed 2019 cashflow, which is a rare circumstance.
This newer approach for underwriting a non-recourse CMBS hotel loan is rekindling market participants’ expectations that CMBS loans are on their way back. Developers and owners are already starting to take advantage of this renewed optimism for CMBS loans and reviewing their portfolios for opportunities to recapitalize recourse debt into non-recourse CMBS debt. Many owners with 1031 exchanges who previously asked for extensions due to the pandemic are also now reentering the market to acquire assets using CMBS loans at prudent leverage. The outlook for CMBS financing for hotels is hopeful, but of course lenders approach different deals differently. While there are fewer lenders offering non-recourse CMBS options than pre-pandemic, we are seeing an uptick of active lenders for bridge financing. The best way to inventory all of your available options and take advantage of improving market conditions is to get in touch with your trusted advisory with deep relationships in the market who can intermediate the best possible debt solution for your portfolio.
Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Allied Member Mag Mile Capital. As a leader in hospitality financing, Shah specializes in structuring and placing high-leverage, non-recourse bridge and permanent debt with cash out for full – and limited-service hotels nationwide. Since joining the firm’s predecessor, Aries Capital, in 2015, Shah has structured and closed hundreds of millions in financing for all property types. Shah has held previous positions at Northern Trust and has an MBA from the University of Chicago’s Booth School of Business.