CRE Valuation&Lending Flashcards
Real estate valuation methodology
-Capitalization Rate
What are the relationship?
property Value = NOI/ Cap Rate
Cap rate is the yield (before interest and tax) on real estate purchased at a given price.
Therefore to value a given property we need to determine
Expected NOI and
a fair, comparable (Comp) Cap Rate
How much pre-tax earning is the unlevered property going to generate each year?
Net operating income NOI
Formula
Total rental income \+CAM reimbursements and other income = Potential Gross Revenue -Vacancy Loss -Collection loss -credit loss -actual CAM expenses -Unrecoverable exp. -other operational exp. =Estimated Net Operating Income (NOI)
Amortization
Lenders
Borrowers
Borrowers want the amortization as longer as possible since they want to constantly refinance it
However
The lenders want to amortization shorter since the longer the risked it will be
Since the property value may go down
Why cap rate goes down sometimes?
Remember the worksheet
Since the cost of debt goes down
Remember the relationship of cap rate and rent rate and NOI, PPTV
When Cap rate goes up, PPTV goes down; when NOI goes down, PPTV goes down
What is a fair return (cap rate) for a given property?
Cap rate are market driven and impacted by?
4%-9% range in the U.S. is fairly common.
A true Cap Rate is determined when a property is sold
As a lender, if be conservative, may set higher cap rate when value the property.
Cap rate are market driven and impacted by
- Interest rates ⬇️
- Economic cycles⬆️
- Debt market conditions -good
- Trends in rents⬆️
- Vacancy rates⬇️
➡️cap rate⬇️ and prop value ⬆️
Recourse
Lend with recourse: personal liable.
Recources back to the developers, the original
If I am the bank, I want recourse. It is double credit:
- The prior credit
- The who you are recourse to
Real estate lending key criteria
- Loan -to-value (LTV)
2. Debt -coverage ratio (DCR) or Debt-Service ratio (DSR)
How to value LTV?
For lender, lower LTV will reduce loss severity (risk) in foreclosure.
Usually will not go above 70% for setting Max. LTV
For borrower, higher LTV reduces capital at risk and provides leveraged returns.
How to evaluate DSC?
Actual DSC = Monthly NOI / Debt service (principal and interest)
Used by bankers to size the appropriate loan amount
How much debt can the borrower afford given the NOI produced by the property?
Higher DSR implies bigger cash flow cushion (less risk) for lender.
Bank usually set 1.1-1.4 as min. DSC
How to value a property and set a loan size?
- Set up underwriting criteria, and then calculate the
- Monthly CF( = annual NOI/12)
- Max. loan pmt (=Monthly NOI / min. DSC ratio)
- Number of payment (12*loan amortization year)
- Loan size from Min. DSC (n, i=loan interest rate for loan sizing from criteria, pmt=max. loan pmt, fv=0, Cpt PV)
- Loan size based on max. LTV (=PPTV * Max. LTV %)
- Leaser of two would be the loan size. - Calculate the loan size offered with 1) monthly loan payment (n, fv=0, i=interest rate on loan (rf+spread), pv=loan size, Cpt pmt), 2)actual LTV (=loan size/ pptv), and 3)actual DSC (=monthly NOI/ monthly pmt).
- compare the Actual DSC and LTV with the underwriting criteria. As lender we want DSC higher and LTV lower.
- Underwriting calculation
Estimate Property Value =NOI/Cap rate
Monthly NOI cash flow=projected annual NOI / 12
Max. Mortgage payment = Monthly NOI / min. DSC criteria (1.3)
Number of payment = amortization year 20 * 12 =240
Loan size from min DSC: N=240, FV=0, i=6%, pmt=max Loan pmt after DSC, Cpt PV
Loan size based on Max. LTV = estimated property value* max. LTV criteria. ( eg. 70%)
Lower of Loan size min. DSC and max. LTV = loan size offered
Other credit factors to consider
- Property type and quality
- Property’s competitive market position
- Lesser credit strength
- Lease term (maturity) and condition
- Vacancy rate (past, present, and future)
- Leasehold or free simple: don’t own the land?
Focus on rent:
-are rent at, above, or below market
-are rents fixed and for how long? What option of rents % of sales?
-rent trends and factors driving rents (economy, new construction, vacancy rates) - Zoning issues and requirements-potential for property improvements and expansion
-best use of property - Current economy and other macro condition
- NOI growth and Volatility
- Are improvement necessary? If so, who covers property improvements? Tenants or owners
- Natural disaster and other risks, insurance coverage
- Loan offer conclusion calculation
Monthly loan payment= n:240, fv=0, i=interest rate on loan ( rf+spread), PV=loan size, CPT: pmt
Actual LTV= loan size offered / estimated Property value
Actual DSC = Monthly NOI/ Monthly loan pmt
- As lender, we want LTV < max. LTV
And. DSC > Min. DSC
Underwriting a real estate loan
- Determine underwriting criteria given property and market
- max LTV
- min DSC
- loan interest rate for loan sizing purposes
- amortization period - Conduct full property due diligence
- Calculate an acceptable loan amount base on underwriting criteria and due diligence results
- Considering the loan’s risk, maturity, market conditions and other factors, set loan interest rate (risk free+ spread). Fixed or floating?
- Set key terms and conditions
- Draft and execute loan agreement
- Loan are a negotiated process between the lender and borrower
Set key terms and conditions
- loan maturity and amortization
- Recourse or non-recourse
- security provision
- Covenant such as maintaining DSR levels, providing financials, limiting debt, insurance, etc.
