The Impact of COVID on CMBS Assumptions

CMBS works because of the ‘locked out’ nature of the underlying loans. The ultimate investors in CMBS are able to rely on a certain return on its investments for performing loans and therefore, pay a higher price than a bond with uncertain returns. That is why it is very prohibitive to pay off a CMBS loan ahead of its term. Most CMBS loan documents require (a) the loan be defeased, or (b) the loan to be assumed. 

Defeasance provides a way for the current owner to sell the property and yet pay the CMBS investors the same amount of return as if the loan were in place. I don’t want to devote time in this article explaining the details of defeasance, but the bottom line is that when interest rates are low (which they clearly are now), defeasance is usually too expensive of an option. That means that one of the most likely ways a sales transaction will get done in CMBS is when the buyer assumes the existing loan. This is a common scenario but COVID has introduced new questions into the process. These include:

What happens when the purchase price of the property is equal to 100% of the loan? Does the buyer have to pay the loan down?

What happens to all those past payments that were deferred or not paid during COVID?  Does the buyer also assume the forbearance or modification terms granted during COVID?

Can a loan in special servicing be assumed? If so, how is the process different than for a performing loan in master servicing?

This article will provide the answers to these questions.

What happens when the purchase price of the property is equal to 100% of the loan?  Does the buyer have to pay the loan down?

Because of the locked out nature of CMBS loans, CMBS loans cannot be prepaid; either fully or partially, so a paydown of the loan is not allowed.

However, pre-COVID, most servicers required an LTP reserve, which required the buyer to deposit with the servicer a reserve intended to maintain the same LTV at origination of the loan.  As an example, if the LTV at origination was 65% and then, at sale of the property, the LTV was 75%, the servicer required a 10% reserve which served only as additional collateral for the loan. The funds could never be touched during the life of the loan. This requirement had the net effect of killing many sales.

If the servicers required this same LTP reserve at the sale of a loan in this early stage of COVID recovery, most people would not be able to sell their property.  We have seen the servicers agree to a much higher LTP/LTV at time of assumption if the LTP/LTV decline is the result of the impact of COVID and not a systemic larger valuation problem.

I remain hopeful that this trend will continue so current owners have the option to sell their properties even in this highly challenged valuation market.

What happens to all those past payments that were deferred or not paid during COVID? Does the buyer also assume the forbearance or modification terms granted during COVID?

All buyers need to know the answers to the following questions before deciding to purchase a “COVID impaired” property.

1. Did the current owner get a forbearance or modification of the loan during COVID? 
2. If the owner did get a forbearance or modification,  is the agreement assumable or does the loan revert to the original terms at time of assumption?  
3. Are there deferred amounts that become due and payable at the time of an assumption?  
4. Are there conditional waivers of fees that become due and payable at another event of default in the future? A buyer will not want to learn about that later!
5. Is the loan completely current at the time of purchase, or are there past due funds that will have to be paid at time of assumption? 

As in all commercial real estate transactions, the answers to these questions have serious consequences to the success of the purchase and sale, let alone the assumption of the existing loan.

Can a loan in special servicing be assumed? If so, how is the process different than for a performing loan in master servicing?

The difference in the policies and procedures for a loan in special servicing are completely different than for a loan in master servicing. This is all due to the REMIC rules which govern the servicers actions in a CMBS loan.  Loans in master servicing cannot be “modified” in any way while loans in special servicing can be modified. It is that simple!

So, when a loan is being assumed and it is in master servicing, the master servicer will be required to follow all the rules of underwriting to ensure the ultimate investors in CMBS are not harmed in any way. Where there is an LTV issue, an LTV reserve will likely be required. Where other reserves are deemed inadequate for the property needs, additional reserves will be required.  When a servicer deems it necessary, they will require cash management.

Whereas, when a loan is being assumed and it is in special servicing, the special servicer has the discretion to do what is necessary to get the assumption closed, where the buyer is equally as strong as the seller in terms of financial strength and experience. 

The special servicer may or may not require additional reserves and may or may not be concerned about the current LTP/LTV.   The real consideration for loans in special servicing is the past due amounts on the loan, including all accrued fees (and those can be very large, especially for loans in special servicing for a long time). Either the buyer or the seller will need to pay these amounts at the time of closing of the assumption. 

When starting a CMBS assumption in 2021, be sure to understand all the questions addressed in this article as well as how each servicer typically solves for the impact of COVID on commercial real estate.

Ann Hambly is the Founder and CEO of 1st Service Solutions, which  has expedited approximately 200 assumptions each year since inception in 2005, or 3,000 total.