Suppose you own a downtown, twelve-story office tower upon which you have a conduit loan. The vacancy rate among office buildings in central business districts (CBD's) right now is on the order of 20%, especially if the office building is older than 15 years old. A central business district just means the downtown area of a larger city where most of the buildings are tall. Your office building is 45 years old, and the building is 33% vacant. But you suddenly have an epiphany. You can convert the property to a mixed use project. A mixed use property is one where the property has both a commercial component (retail or office or both) and the property has a residential income component (apartments). Mixed use projects are all the rage these days because young college graduates are fed up with long commutes from the suburbs. They want to live close to work, and by living in the central business district they can either walk to work or take a tram or bus. The idea is brilliant. You can convert the bottom floor to retail, maybe a convenience market and coffee shop. You can convert the second floor to a health club. The area is desperate for one. And the top ten floors you can convert to apartments. Your net operating income will triple! The value of the conduit's collateral will triple. Everyone wins. So you sit down with the conduit and lay out your plan. The loan servicing officer sadly shakes his head. "I'm sorry, Mr. Investor, but I cannot allow you to make any structural changes to the property." You shout at him, "Are you nuts? This will triple the value of your collateral!" The loan servicing officer replies, "I believe you. That's not the problem. My trust documents require me to forbid structural changes to the property." What on earth is going on here? The problem is a tax problem. A commercial mortgage-backed security (CMBS) is a bond secured by a pool of mortgages. Someone has to own that pool of mortgages. That pool of mortgages generates millions of dollars in interest income every month. If a corporation or a limited liability company owned this pool of mortgages, they would pay millions of dollars in taxes on that income. Then, when the bondholders got their interest checks, they would have to pay taxes a second time on that income. They would suffer double taxation. In order to foster the growth of an organized market for commercial mortgages, the Federal government created an exemption for passive trusts that merely hold the mortgages for the bondholders. If the trust remains passive, the trust does not have to pay millions of dollars in taxes. HOWEVER, IF THE TRUST GETS INVOLVED IN THE ACTIVE MANAGEMENT OF THESE MORTGAGES, THE TRUST LOSES ITS TAX-FREE STATUS ON EVERY LOAN IN THE POOL. Holy mackeral. Now you can see why the conduit loan servicing officer had no ability to use common sense. The bottom line is that if an investor accepts a loan from a conduit, he is giving up his right to make any structural changes to the property ... unless he negotiates the right to make the exact structural changes before the loan closes. Once the loan closes, it is too late to go back and amend the documents. Conduit loans indeed have attractive rates, but an investor gives up a lot when he accepts one. You can apply to 750 different commercial lenders, including many banks making portfolio loans who have more flexibility, by using C-Loans.com. | 
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