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FORGET THE FANTASY EQUITY, THE FLUFF IN FINANCIAL INSTITUTIONS’ COMMERCIAL REAL ESTATE BALANCE SHEET ASSETS AND THE OPPORTUNITY FOR PROPERTY INVESTORS

Some quick math on CRE loan collateral and prospective future loan losses and opportunities. The build-up of non-performing/underperforming CRE loans on the balance sheets under OCC, FDIC & Fed policies got us thinking:

Nationally, we have seen an average 250 bpt increase in CAP rates (and some would argue 300 bpt), and a resultant loss in value of CRE as follows:

There are approximately $3.5 trillion of CRE loans outstanding at this time. Assuming an average LTV of .75, the CRE collateral was valued at loan inception at $4.2 trillion. So, assuming an average CAP Rate for CRE of 6, we can derive that the implied NOI at loan underwritings was $252 billion ($252 billion/.06=$4.2 trillion). Increasing the CAP Rate by 250 bps to 8.5 results in a reduction of CRE loan collateral such that it is now worth $2.965 trillion, or, $1.235 trillion less than at loan inception underwritings. From this we see that at current values the $3.5 trillion of outstanding lender CRE loans are undercollateralized by about $535 billion. But, this of course ignores the declines in operating performance that have been experienced during the last 24 months and which continue to deteriorate with each passing month. Taking a stab at quantifying operating performance declines, we could say that broadly, NOI is down 10-30%, depending on asset class. Taking a conservative number of 15% and applying it to the $252 billion of NOI at loan inception underwriting, we find that current NOI may in fact be something like $215 billion. Using our current 8.5 CAP Rate, we get a current value of $2.529 trillion. This suggests that lender CRE loans are underwater by about $971 billion, let’s call it $1 trillion. This shows the capital gap and the opportunity for new investors like U.S. Southwest Fund, who buy in to CRE assets at a discount to original property value and loan value. 

As an interesting side note, using our assumptions above, we can quantify the lost investor equity since the onset of the financial crisis at $1.05 trillion (25% of  $4.25 trillion). So, taken together, lenders and equity investors have lost a total of $2 trillion.



Disclosure: no positions