The attractiveness of low interest rates, long maturities and high loan to value is often times a developer’s dream. The CMBS market provides these attributes which can entice property owners. The structure of the servicing of CMBS loans is two tier with a master servicer (often a financial institution with a strong back room) and a special servicer. The master servicer is responsible for collecting mortgage payments and funded escrows for property taxes and insurance. The master servicer has very little latitude in modifying the terms of the mortgage. Such modifications sought often include deferrals of payments for lease up costs and retenanting. These requests are never handled by the master servicer who has a strict playbook to follow.

Loan modifications or other requests are often handled by the special servicer. The special servicer cannot “own” loans and is often a hedge fund that has also bought a tranch of the CMBS pool to monitor opportunities to acquire defaulted assets at great discounts. The special servicers through affiliates can be very aggressive in getting control of properties by enforcing default provisions, seeking receivers (many of which they have long relationships with) and seeking assignments of rents etc. The special servicer seeks to issue technical defaults (lack of compliance with stringent reporting requirements), makes allegations of fraud, and aggressively computes default interest for any default (whether or not previously declared by master servicer) as a way to gain leverage in securing an ownership position in a good asset. If there is a default and there is equity in the property, the odds of the loan being sold to a hedge fund are much greater.

The developer is often frustrated in not being able to negotiate directly and make a deal to continue to own the property under revised terms. Unlike the Bank, which many developers are accustomed to dealing with, an affiliate of the special servicer wants to own the property or liquidate quickly on an over inflated claim (default interest and yield maintenance premiums) which drive the secured claim higher. The developer has two choices, give up or fight costly litigation to maintain their position. If you choose CMBS financing the Latin term “caveat emptor” takes on new meaning.

My opinion after watching the overaggressive hedge funds who buy into tranches of CMBS pools is make sure you over leverage your property at the beginning. You might as well treat your financing like a sale. The complication of trying to refinance or sell a property with a CMBS mortgage does not make it a cost effective financing. My advice is don’t use CMBS financing for properties you will want to eventually sell or refinance. It is a very costly capital structure in spite of the favorable initial terms for rate and maturity because of the yield maintenance requirements.