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Commercial MortgageInsight
T H E M A G A Z I N E F O R C O M M E R C I A L M O RT G A G E F I N A N C E VOL. 10, NO. 2 ~ NOVEMBER 2005

INSIDE INSIGHT

F E AT U R E S
Investment Strategies
9
Weary of high-leverage deals, those in
the CMBS market are voicing their concerns
over the quality of credit for new issues.

INDUSTRY PERSPECTIVE:
Conduit loans offer com-
mercial real estate bor-
rowers very attractive
rates, but repayment
terms may end up cost-
ing more than the poten-
tial savings. Page 2.

Dealmaker Insight
14
Mid-cap investors and developers are
aiming to change the portfolio structure of
seniors housing and care facilities.

Insurance
16
As property owners in the Gulf Coast
region face the challenges of rebuilding, seri-
ous questions are being raised about insurance
coverage.
Property Report
18
The condo hotel business has been
booming across various markets, creating op-
portunities for lenders to be burned legally
and financially.

Directory
22
Outsourcing and deal-management
functions can be accessed through CMI’s
Directory Of Industry Service Providers.

Specialty Financing
26
With competition for deals at a fever-
ish level, borrowers may be surprised to dis-
cover which institutions are offering specialty
real estate financing these days.

DEPARTMENTS
2 Agenda 19 FYI
3 Reports 21 Dealmakers
13 Calendar 30 Networking

Copyright © 2005 Zackin Publications Inc. All Rights Reserved.

 Commercial MortgageInsight
Reprinted with permission from the November 2005 issue.
®

Conduit Loans Offer Excellent Price

Execution With Some Subtle Strings Attached
Borrowers must be aware of the details when opting for the
less expensive choice of executing a loan from Wall Street.
BY CARLTON ROARK

T
he emergence of conduit
lending in the mid-1990s and
its current popularity have
unquestionably been a boon for com-
mercial real estate investors. Where
else can one obtain long-term, fixed-
rate financing that’s often as much as a
full point or more below the best rate
available from traditional lenders?
To the surprise of many, the old
adage that “if it’s too good to be true,
it’s probably not” doesn’t actually apply
to conduit lending because the low
rates being offered by conduits are, in
fact, available. However, that may offer
little comfort to those who take the
bait and later come to realize they are
now confronted with another, more
ominous old adage: “The devil is in the
details.”
Those most often confronted with
this distressing realization are usually
those who suffer from the rate-shopping
malady known as “interest-rate
myopia” in which the lowest rate of
interest is elevated to such a level of
paramount importance that it effec-
tively renders irrelevant any serious
consideration of other loan terms and
conditions.
Regrettably, those who’ve suc-
cumbed to the siren song of conduit
lenders soon find themselves acquaint-
ed with a loan process characterized by
many as grueling, onerous and expen-
sive, but that’s not the worst part. Aside
from the kind of loan provisions some-
times required by traditional lenders,
like impounds, prepayment possible rate. However,
penalties and annual financial with conduit loans in par-
reviews, loan provisions are ticular, the rate of interest
often required by conduit is just one component of
lenders that are seldom, if ever, many, and for borrowers
imposed by traditional lenders. who ignore or downplay
These include requirements to the importance of those
obtain terrorism insurance, zon- Carlton Roark remaining components,
ing compliance certification and the consequences can be
proof of occupancy rights, lock- quite costly.
box/springing lockbox provisions, legal Based on the true comparative costs
opinions, single-purpose entity forma- involved, in the final analysis, choose a
tion and, most notably, lockouts and conduit loan may ultimately represent a
defeasance. case study in irony for those who
With regard to the latter, nothing choose a loan for its low rate and end
elicits more consternation or regret up incurring costs far greater than any
than when a conduit borrower becomes savings they had hoped to achieve.
fully aware of the implications associat- The advantage, in this case, goes to
ed with lockout and defeasance provi- the borrower who resists the tempta-
sions. Lockouts are periods of time in tion of low rates in exchange for flexi-
which a loan cannot be paid off at all, ble repayment terms.
even with a prepayment penalty. Most agree that the historically low
Even after the lockout period, a con- interest rates we’ve enjoyed over the last
duit loan may only be paid off through four years have given investors ample
a very expensive process known as justification for acquiring real estate at
defeasance. Defeasance allows the pre- cap rates lower than they would have
paying borrower to replace a real estate ordinarily accepted - based on the buy-
mortgage with a synthetically created ers’ analysis of cash-on-cash returns,
package of non-callable and non-pre- which are heavily influenced by the pre-
payable U.S. government securities as vailing interest rates on debt financing.
substitute collateral. The total process However, if overpaying for low-cap-
of defeasing a loan can easily cost as rate commercial properties can be jus-
much as 10% to 20% of that loan.
Carlton Roark is a commercial real estate
True comparison lending professional serving the San Diego
Conduit financing does have its and Riverside County areas of Southern
advantages for those seeking long- California. He can be reached at (877)
term, fixed-rate financing at the lowest 562-6633, ext. 1.

Subscription information available online at www.cmi-online.com. Copyright © 2005 Zackin Publications Inc. All Rights Reserved.
 tified because of low interest rates
from traditional lenders, then conduit
lending - with its much lower rates of
interest - most certainly exacerbates
the problem. But it does so in a way
that may be far less obvious to many
lenders and their borrowers.
Overlooked factor
When an appraiser cites commercial
sale comps for a property that will not
be financed with a conduit loan but
neglects to verify, and thus adjust for,
sale comps where conduit financing was
involved, the legitimacy of those comps
Subscription information available online at www.cmi-online.com.
has to be questioned. Why should prop-
erties selling at low cap rates because
they meet stringent underwriting guide-
lines and because the owners are willing
to accept onerous loan covenants to
secure conduit financing be considered
as comps for those that do not?
There are higher costs (economic and
otherwise) associated with the use of
conduit financing. To apply the low cap
rates found on newly sold properties
financed with a conduit loan to the val-
uation of those that were not creates a
dangerously and artificially inflated
value on the latter that just isn’t sup-
ported, but is oftentimes dismissed as
nothing more than a function of excess
demand over supply in that market.
Conversely, when commercial real
estate values begin to correct them-
selves - and they eventually do - com-
mercial real estate owners and their
lenders in markets where conduit
financing played a prominent role may
find themselves quite surprised to dis-
cover that the end product is not what
was anticipated. They may be faced
with the implications associated with a
Trojan horse that has breached the
gates of their investment community. ●
Copyright © 2005 Zackin Publications Inc. All Rights Reserved.