Loan Security SoE Qs Flashcards by Lewis Q

What elements of the Red Book apply to loan security valuations?
Can you summarise them?

VPGA 2 covers Valuations for secured lending

Covers conflicts of interest and reporting procedures

Conflicts of interest must be identified, disclosed and managed, or instruction turned down if you can’t effectively manage. Client must agree

Previous involvement defined as last 2 years - must be disclosed

Reporting procedures - as well as minimum requirements of a valuation report, for secured lending valuations

valuers must:
disclose of any prior involvement
advise on valuation methodology adopted and why
disclose a recent transaction price, or agreed price if there is one
comment on any environmental consideration
suitability of the property for mortgage purposes
any factors that cold impact price
any special assumptions and if these have a material impact on value
sustainability factors are becoming more important and should be commented on

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Can you explain what prudent lending criteria you might recommend to a client?

I would make the client aware of factors that could impact value

I would advise the bank of any upcoming lease events, and recommend they monitor lease renewals at the property
I would advise the client of any environmental risks e.g. EPC, flood risk

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What would you consider when advising whether a property is suitable for loan security?

Security of income - is it let? could it be let? can it generate sustainable income?
Fit for use - is the building fit for its current/intended use? Will it be rendered obsolescent?
Structural integrity - is the building suitable for occupation?
Marketability - Could the bank dispose of the property in a reasonable time frame were the borrower to default on the loan? Who would purchase the property and why? Would the property attract interest/bids?

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What Conflict of Interest process do you go through?
What did you do on X example to ascertain whether a conflict of interest was at play?

Determined no personal interest
Sent out a conflict of interest check email
Referred to our internal conflict register (listing projects, properties and clients) to determine if any previous instructions
Spoke directly with individuals/teams who would be most likely to have undertaken instruction on the property/from the client

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Level 2 - Industrial Doncaster - Key Facts

December 2023
c. 106,000 sq. ft
Passing rent £4.00 psf
9 years remaining on the term
4 years to rent review
Market Rent £4.50 psf
Adopted 8.75% equivalent yield
£4.875m value
Local covenant, tenant been in occupation for 20+ years, but dated property.
Letting evidence between £4.00 psf and £5.00 psf
Large yard but triangular in shape
Property dated - fit for use but ongoing capex would be required
Reflected in yield
VP 9.75% yield - £4.25m

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L2 Industrial Doncaster

You say the layout of the yard was triangular in shape, how did you consider this within your valuation?

Considered within the rent - a more uniform shape would be more desirable BUT it was a suitably sized yard and HGVs were arriving and going without issue. Logistics tenant who reported no complaints

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L2 Industrial Doncaster

Can you tell me what would be considered a good specification for industrial warehouses?

Minimum 8m clear eaves height
Full height loading doors
Typically steel portal frame with insulated cladding
5%-10% office content
Approximate site coverage of 40%
Minimum 30KN/sq m floor loading (kilo-newtons)

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L2 Office Holborn - Key facts

November 2023
Passing rent £52.50 headline
Basement 75% of headline, second floor 95%, third floor 90%
Rack-rented - rent set in 2021
just over 2 years remaining on lease
allowed for 1-year void and 1-year rent free as were informed they were looking to leave
5.5% yield
£4.6m(?)
Borrower had refurbished so no costs included
Grade II listed so no empty rates
included letting fees
considered investment sales and cross-checked with vacant sales

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L2 Office Holborn
How did you consider the tenant’s covenant strength and short lease term?

The tenant was of a reasonable covenant - mid-sized international architecture firm
with 2 years remaining, but they had informed they were likely to vacate.

I considered that investors would view the property as a reasonable investment profile for the local area, but with risk attached to the lease term/vacancy

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L2 Office Holborn
It was a Grade II Listed building - so quite old? How did you measure?

I measured on a dual basis using both IPMS 3 and NIA, as the client requested NIA.

When measuring NIA I measured the occupiable space, taking out columns which were on every floor.

When measuring using IPMS 3 I measured to the Internal Dominant Face (IDF), including the pillars.

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What is the Internal Dominant Face (IDF)?

the Internal Dominant Face is the ‘inside finished surface comprising more than 50% of the floor to ceiling height for each IDF wall section’

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What is the difference between IPMS 3 and NIA?

The main differences are:

IPMS 3 measures to the Internal Dominant Face
it includes pillar/columns - NIA does not
includes restricted height areas of less than 1.5m - NIA does not
Covered galleries and balconies for the exclusive use of one tenant are included and stated separately

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L2 Office Holborn

What void period and costs did you include?

I included a 1-year income void and 12 months rent free in line with evidence and conversations with agents
I did not account for empty rates as the property was Grade II listed
I accounted for letting fees
I did not account for capex as property had been refurbished and M&E upgraded in 2021

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L3 Retail Hampstead - Key Facts

Passing rent £230 ITZA
Over-rented - evidence between 150-210
Strong position but not prime
Settled on £195 ITZA MR
2 years remaining on lease
6-month void as mid-point, no costs
capitalised at 7%/6.5%

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L3 Retail Hampstead
How did you analyse the floor areas on a zoned basis?

Measured the property
Halved back each 6.1m
Small property, Zone A, B and C
A/2 for Zone B and A/4 for Zone C

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L3 Retail Hampstead
Why was the property not along the strongest area of the pitch?

The property was located towards to station - it was in a strong position, however my conversations with local agents confirmed the prime area of the pitch was further down, where the pavement becomes wider. I made sure to confirm with multiple agents

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L3 Retail Hampstead
How did you approach the over-rented nature of the property?

I valued on a hardcore/layer approach - 6.5% on the ‘bottom slice’ (market rent) and 7.5% on the ‘top slice’ (froth - passing rent less market rent)

L3 Retail Hampstead
Why did you conclude it was over-rented?

The passing rent was £235 ITZA, comparable evidence ranged from £150-£210 ITZA and agents advised £235 was strong/rents had come off a little
The strongest rents were a little further down the high street along the strongest part of the pitch, which agents confirmed was slightly stronger than the property’s location
Settled on £195 ITZA which was in line with evidence closest to the property and a small discount from some of the stronger ones
Confirmed with agents appropriate

L3 Retail Hampstead
Why did you conclude the property was suitable for loan security?

Strong location in an affluent suburb of London, close to station
Strong, national tenant
Good marketability were the tenant to vacate or the property come to market
No structural issues etc

L3 Retail Hampstead
What criteria did you advise the bank should monitor?

Most notably the lease renewal, as I’d advised the property was over-rented
I advised on the risks of an over-rented property

L3 Retail Hampstead
What are the risks of an over-rented property?

The occupier trading from the property is at a higher risk of financial struggles due to over-paying rent
The tenant may negotiate to re-base the rent which would mean the income would come down earlier than expected
The ‘froth’/over-rented part of the rent is not a reliable income stream

What is included and excluded in retail NIA?

What is included and excluded in NIA?
Include:
 Entrance halls (if not communal)
 Kitchens
 Built-in cupboards etc occupying usable space
 Ramps, sloping areas and steps within usable areas

Exclude:
 WCs, Cleaners’ rooms and the like
 Lift rooms, plant rooms etc
 stairwells, lift wells and permanent lift lobbies
 entrance halls, atria used in common
 corridors and other circulation areas where used in common
 Permanent circulation areas but not those that are usable areas
 internal structural walls
 Space occupied by permanent air-conditioning, heating etc

L3 Hampstead Retail
How did you measure the NIA?

Excluded WC at the rear, everything else included
Just Zone A and Zone B

L3 Hampstead Retail
Why had rents declined? Tell me about the pitch?

The prime pitch had remained strong but some of the others had declined/this unit was over-rented – agent advised probably strong as the time it let

L3 Hampstead Retail Why did you recommend it was suitable for loan security?

strong position on pitch Good marketability for both occupiers and investors Generating income

L3 Hampstead Retail What advice did you give the Bank?

Advised it was over-rented and to monitor the lease renewal as rents should likely come down Monitor whether there is an early negotiation to re-base the rent

L3 Hampstead Retail What do you mean by prudent lending criteria? What did you advise?

o The banks job is to adopt prudent lending criteria however I’m aware of the role my advice plays in that o I advised on the risk that the property was over-rented o It was a national occupier so unlikely to default o However the rent will likely come down and there is a risk the tenant enters negotiations early to rebase the rent o One of the criteria that Banks lend against is Interest cover ratios, which would change when rent comes down

L3 Hampstead Retail What did you advise the Bank should monitor?

The passing rent, the rent review, if the rent rebases, if there is a void period, any new tenant

L3 Hampstead Retail What was in your SWOT analysis? What are the important property characteristics you mention?

o Strengths – location, tenant, marketability o Weaknesses – short lease term, over-rented o Opportunities – re-base with a longer term o Threats – rent to come down

L3 Office - Forest Gate - Key Facts

8-storey passing rents £11-16 psf Borrower refurbished two floors - one had let at £16 psf and one vacant Market rent on the vacant refurbished floor £16 psf Market rents on other floors £12-13 psf WAULT 3.75 years to expiry and 2.4 years to breaks (excludes vacant floors) Term and reversion 9% on under-rented floors for the term, 10% on reversion, 10% on rack-rented, 11% on vacant reversions c. £2m MV (c. £100 psf)

L3 Office Forest Gate What did you include in your tenancy schedule?

Tenancy start and end dates, rents, break clauses, rent reviews, rental analysis, incentives

L3 Office Forest Gate What did you note from the leases?

Standard terms in terms of repair clauses, insurance etc, service charges explicit, typically 3-6 months rent free on 5 years, one or two were 10 years with 5 year break and rent review

L3 Office Forest Gate How did you calculate the WAULT?

Using excel I multiplied rent of each lease by the years remaining Summed the weighted terms divided by the total passing rent didn't include the vacant floor

L3 Office Forest Gate What was the WAULT at this property and how did that impact your analysis?

3.75 years to expiry and 2.4 years to break Risky asset = high yield, however was in line with similar comparable evidence

L3 Office Forest Gate What was the specification and To what spec had they refurbished the floors?

The unrefurbished space was perimeter trunking, no air-con, wall mounted radiators, suspended ceilings w/ strip lighting, concrete construction, SG windows Refurbished space had secondary glazing, new carpets and LED lighting, new WCs, new kitchen areas

L3 Office Forest Gate Why did you adopt term and reversion yields? What is the benefit?

I adopted term and reversion yields on the under-rented floors as this is the appropriate way to approach under-rented properties. The lower yield represents the lower risk of the under-rented income flow, and the resulting yield profile is reflective of the investment.

L3 Office Forest Gate How did you assess blended yields against comparable investment evidence?

I collected my evidence and consider those that have a similar income profile to the property (multi-let, similar rents/risk). Initial yield lower due to vacancies, reversionary in line with comps I would expect the resulting yield profile to reflect a similar level to those comparables if comparables are rack-rented - the reversionary rent should reflect similar levels if comparables are under-rented, I would consider the initial and reversionary yields against each other

L3 Office Forest Gate How did you consider the WAULT in your analysis?

The WAULT for this property was 3.75 years to expiry and 2.4 years to break If a comparable transaction has a longer WAULT, typically this reflects a sounder investment profile and would attract a lower yield, and vice versa

L3 Office Forest Gate What are the risks associated with vacant space that you made the client aware of?

Vacant space not only means an income void, but also empty rates costs, upcoming letting fees to re-let the space, and a service charge shortfall in multi-let properties These reduce the income profile of the property and therefore impact the value Also added risk typically leads to a higher yield in the eyes of investors If there is a downturn in the market, space could become difficult to let

Did you consider alternative uses?

Yes however due to multi-let nature and years remaining on the leases, we advised unlikely

L3 Office Forest Gate Why was the property suitable for a loan?

Generating income Suitable for local market - low quality space but affordable rents Marketable to small local businesses, and investors looking for high yielding investment in an improving area of London

Differences between process for Loan Security vs other valuations?

Must declare involvement in previous 2 years Special assumption of Vacant Possession Advise on marketability and value of building over term of the loan - obsolescence Define risks & SWOT analyses