2houndz

With $770B of the $1.4T in commercial mortgages maturing in the next five years currently underwater, FDIC revises its rules (.pdf) to allow banks to keep loans on their books as 'performing' even when the underlying properties no longer cover the outlay.

@bbro - Great comment, but keep in mind that market rent is whatever a property will sell for on the open market, so this suggests that nearly everyone in the business of buying CRE had blown a bubble in the market. If a handful of buyers had paid above the market the whole sector would not be in this mess.

I took your scenario a step farther and applied some rough numbers to it. I don't necessarily agree with your assumption of 75% ltv - I think it was typically higher than that, which magnifies the problem even further, but I used what you have started.

I did this quickly with a sheet of paper, so I took liberies in the rounding. If a $10MM loan was used to purchase an asset for $13.3MM, and assuming a 7% CAP rate the Net Operating Income (NOI) would have been $930K and the debt service would have been 720K at a 6% rate, resulting in net cash flow of $210K. I assume that NOI is made up of just over $1MM income and 100K of non-recoverable costs (10% of income).

Now lets assume that the rent drops 17%, which is what we have been seeing in the office sector. That would be 860K in income and the non-recoverables would not change very much. In fact they might increase due to increased marketing, a shouldering of the utilities cost that may have been paid by the former tenant, etc. NOI is now $760K and the income now barely covers the debt service (it probably doesn't at the end of the day by the time we clean up my rounding and throw in other non-recoverables that I ignored for the sake of simplicity). The CAP rate may now be 9-11%, which we are clearly seeing throughout the industry. If we take the better end of that at 9% our value based on income is now $8.4 MM. It is easy to see why an owner with non-recourse debt would consider walking away.

Now going back to my original statement we realize that an entire industry fell into this trap. We are not talking about a few that paid above market. Over the next few years as these loans roll over this will play out over and over and....


On Nov 01 12:32 PM bbro wrote:

> A 10 million loan implies the property was worth 13.3 million
> (75% LTV) and the property is now worth 6 million...55% decline in
> value...they must have bought higher than the market highs....<br/>