Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
Issue link: http://cire.epubxp.com/i/64804
Property Value and Loan Loss Over Time 25,000 20,000 15,000 10,000 5,000 0 1 (5,000) Future years Loan loss/gain Estimated value of project and employ management to ensure the prop- erty is maintained. Even if the answer is yes, the lender should evaluate the outlook for market conditions and off set any potential gains against fund- ing operating costs during the hold period. If the lender perceives a positive net gain over the hold period, it may elect to hold and fund operations. Determining Value Lenders are required by law to receive Financial Institutions Reform, Recovery, and Enforcement Act-compliant apprais- als on real estate held as collateral. In the current market, many appraisals establish values with the caveat that the highest and best use of a particular property would be to hold the property until more-normal mar- ket conditions return. T e appraisal, therefore, establishes a value of an illiquid asset, while the lender is interested in the value at which the col- lateral can be converted to cash. As a result, lenders should consider other avenues for testing values. One approach is to request a broker opinion of value, engaging a bro- ker with condo experience, comparable sales in the geographic market, and mar- CCIM.com Debt + holding costs keting successes. Another approach is for the lender to review its own loan portfolio for recent sales of the product type in the geographic market. A third approach is to hire an adviser to consider all the aspects mentioned above, plus provide an indepen- dent view of the local market conditions. T is expands the review to include further analysis of operations and a comparison of hold time, projected value, and ongoing operating costs. Operating Costs Typically the original developer of a condo development hires a property management group to manage the property until it is transferred to the unit owners based on the condominium declarations. But oſt en the property manager's decisions are driven by the HOA's board of directors, which oſt en includes the developer as president. This symbiotic relationship may mask a number of unseen operating costs. For instance, the level of deferred maintenance may not be openly shared with the lender. Other hidden costs may be delinquent pay- ment of association dues, property taxes, and fees. T is can result in reduced recovery to the lender as units sell, because unpaid asso- 2 3 4 5 6 7 8 9 10 ciation dues must be remitted to the HOA upon sale of a unit. T e HOA board of directors instructs the property manager and infl uences the operat- ing rules of the association, which establish cost structures and maintenance plans. A developer may be keeping HOA dues artifi - cially low to reduce the payments upon sale to the HOA. T us, unfunded operating costs may be pushed to the lender. Alternatively, the HOA dues could be increased to bring in more cash from third-party owners immedi- ately, while reducing future recoveries from unit sales. Condominium laws are diff erent in each state and oſt en require a professional man- ager to ensure compliance. Legal counsel may need to review the current HOA status; however, the developer may skirt the issue to avoid legal fees, creating more future costs for the lender. Graphing the Result A graph comparing hold times to net values may best illustrate the lender's choice. T e accompanying chart depicts the property with a current market value of $7 million and a current debt balance of $9 million. It assumes that the market value will improve rapidly during years four through seven. It also assumes that debt and holding costs will increase by 10 percent per year. This analysis illustrates the challenge posed by the difference between current appraised values and market clearing val- ues, and the costs to carry real estate assets. In the example above, if a lender accepts the assumptions for market changes, the lender may opt to incur the holding costs for the next fi ve years to have an opportunity to sell at break-even or at a gain starting in year six. T e key risk lies in the assumptions used to determine market appreciation, compared to the hold costs. Condo workouts are not easy but a third- party adviser oſt en provides the clear-eyed vision needed to see the whole picture. Jay Kelley and Juanita Schwartzkopf are man- aging directors at Focus Management Group headquartered in Tampa, Fla. Contact them at j.kelley@focusmg.com and j.schwartzkopf@ focusmg.com. May | June | 2012 17 Dollars in thousands