Open Prepayment in CMBS???!?!?

April, 2015

CMBS loans have numerous benefits, but prepayment flexibility is certainly not one that is normally associated with the product. As a result of fierce competition these days on Wall Street, and over 40 lenders competing in the space, lenders are continuing to find creative ways to engineer the loan product to meet the demands of borrowers.

Recently we were approached by a client whose transaction fit the CMBS bill in just about every aspect but one. flexible prepayment. This borrower is a value buyer who has purchased a number of facilities over the past several years, all of which were value-add transactions. The properties typically suffer from severe mismanagement and often have deferred maintenance that needs to be addressed through a capital improvements plan; the assets can be purchased at well below replacement cost and value/cash flow created after the properties are improved and occupancy is restored.

This client recently hired The BSC Group to identify refinance options for an asset in exactly this situation. The borrower had purchased the property 24 months prior, and after implementing his business model the asset valuation and cash flow is dramatically improved. The investor was looking to refinance the asset with the stated goal of recovering all of his equity, as well as cashing out additional capital for future acquisitions. This borrower is also looking to remove the recourse on his personal balance sheet by accessing the nonrecourse debt market.

All of the deal points outlined by the client are readily attainable with a CMBS execution, save one. Long term, the borrower is not committed to the market that the property resides in. Since the borrower does not have a large footprint in this particular market, the operational economies of scale are questionable, and this factor is leading the borrower to believe that a sale of the asset is highly probable in the 3-5 year time horizon. In addition, the full upside of the asset has not been achieved, so the borrower is concerned that long term debt with rigid prepayment may lead to an equity gap that could limit his pool of future buyers, even if the loan could be assumed at a very attractive interest rate. Finally, the borrower is well aware of the cumbersome nature of CMBS prepayment, and for these reasons the borrower did not think that a CMBS loan would be an appropriate option.

After packaging and marketing this transaction in the market we received numerous loan options for this borrower. Many different types of lenders had interest, but all had different limiting factors given the circumstances at hand. Banks were interested in the loan for a balance sheet execution, but on a nonrecourse basis they were not excited about all the cash out after such limited ownership tenure, and as such they wanted to limit proceeds or take some level of recourse. Alternatively, nonrecourse bridge lenders were interested in the deal, however the pricing and other terms were not overly attractive to the borrower relative to what the CMBS market could offer. Every lender liked this deal but struggled to find a way to meet all of the borrower's deal points, or so it seemed.

If only there were a way to structure a CMBS loan with more flexible prepayment, it seemed this would be the perfect option to skin this cat and meet all of the borrower's criteria. Upon further review, however, with proper consideration several CMBS lenders in the market were in fact willing to provide a prepayment structure that would meet the client's needs. The market spoke and provided the borrower with the following prepayment options:

  • 12 months open prepayment for an additional 10 basis points in spread
  • 18 months open prepayment for an additional 30 basis points in spread
  • 24 months open prepayment for an additional 60 basis points in spread

At this time this small $2.6MM loan is under application with a CMBS lender with the following structure:

  • 5 Year Term
  • 30 Year Amortization with 12 Months Interest Only
  • 24 Month Lock Out
  • Yield Maintenance Months 25-41
  • Open Prepayment Month 42-60
  • 0.5% Assumption Fee
  • Spread Premium of ~30bps for 18 Months Open Prepayment
  • Pricing: 5 Year Swap (1.48%) + 274 + 30 = 4.52%

Bottom line... this creative loan structure will allow borrower to refinance an asset that was purchased two years ago with nonrecourse debt, recapture all of the equity that was used to acquire and rehab the property, plus additional cash from the value add, and have a loan with the prepayment flexibility he needed to feel confident about his long term exit strategy, at 4.52% fixed for the term of the loan.

April 2015

This article was written by Shawn Hill, President of The BSC Group. For more information, view the Team Member page.

The BSC Group has been voted Best of Business - Finance for five years running by the readers of Inside Self-Storage.

ISS Best of Business 2015 Award