Prior to the 2007 global credit crisis, a popular method of mortgaging an apartment building was through the commercial mortgage-backed securities (CMBS) market. Also known as conduit financing, this product had many positive features that created a competitive alternative to Canada Mortgage and Housing Corp. (CMHC) mortgage loan insurance and conventional financing.
CMBS mortgages offered longer terms, competitive interest rates, higher leverage, longer amortizations and limited personal guarantees. This mortgage product became a popular option, especially for landlords in secondary markets and for those who wanted an alternative to CMHC mortgage loan insurance.
However, many borrowers found the product frustrating, especially when some lenders made the decision to have their loans administered by third party servicers in the U.S. Also, the opportunity for secondary debt was generally prohibited and early pre-payment was more costly than conventional loans using defeasance rather than traditional yield maintenance.
Several of the Canadian companies offering CMBS were First National Financial LP, Merrill Lynch, Capmark Financial Group Inc., Colliers International and Column Financial Inc. The competition created by these groups caused a compression in mortgage spreads to record lows, which were well below the long-term average of approximately 175 basis points over Government of Canada bonds.
In August 2007, the credit crisis hit the U.S. financial markets, which had a severe impact on the Canadian securitization industry. Bond investors fled the CMBS market leaving lenders panicking to find alternative funding solutions for their committed conduit mortgages.
The lack of bond investor demand for the product and the unattainable yield expectations resulted in the death of the CMBS market in Canada and the U.S. for several years.
CMBS today
It appears the CMBS market in Canada may be finally coming back to life. There are a number of securitization lenders that have entered the market and had success selling their mortgage pools into the bond market. As investor demand and confidence comes back to this sector, look for additional lenders to get back into the market by the end of the year.
The product features will be similar to the mortgages funded through the CMBS program prior to 2007. Borrowers will be able to obtain up to 80 per cent leverage, 30-year amortization periods, competitive interest rates (between 250 and 275 basis points over Government of Canada bond yields) and non-recourse in some situations.
Although secondary debt will continue to be generally prohibited, administration of many of the pools will be processed in Canada, providing improved customer service and lower administrative costs. Defeasance pre-payment calculations will be replaced by standard interest rate differential pre-payment penalties. Most importantly, 10-year terms will be available for ‘B’ quality properties and secondary market locations.
Right now, the best option to finance an apartment building (in the majority of situations) is through CMHC. The long-term benefit of lower interest rates provided by CMHC insurance is typically the best solution for most landlords. However, with conventional lending at the banks becoming a much more tedious process and CMHC continuing to use an internal market valuation, a CMBS mortgage is a worthwhile option for borrowers to consider.
Peter Cook and Robert Fleet are apartment finance specialists with First National Financial LP. First National is the largest apartment lender in the country and one of a few companies that has access to all three mortgage products: Canada Mortgage and Housing Corp. mortgage loan insurance, conventional financing and commercial mortgage-backed securities.
