What value are Banks lending on?

[Steve Taylor]

I'm having a discussion with a loan officer about what value to lend on. We are contemplating a construction loan to build a spec office building. We have two market values from the appraiser. One is the "as stabilized" market value of $2,800,000 as of 2/10 which is assuming 95% occupancy at that time. The other market value is the "as completed" value at 2/08 of $2,300,000. He gets to the $2,300,000 by deducting rent loss and tenant finish from the "as stabilized" value. It looks to me like the appraiser did the appraisal correctly and is leaving it up to us as to which value we want to loan on. The loan officer believes we should loan 80% of the $2,800,000 value as of 2/10. He bases this on his contention that all Banks loan on the "as stabilized" value and that is what we have always done in the past and adds that the appraiser has also told him that "as stabilized" is the value Banks loan on. It seems to me that we should only be loaning on the "as completed" value. I base this on Federal Reserve SR94-55

SR94-55

which says in part "For proposed and rehabilitated rental developments, the appraiser must make appropriate deductions and discounts for items such as leasing commissions, rent losses, and tenant improvements from an estimate based on stabilized occupancy."

I can't see why we would loan on a future value instead of a discounted value. I'm wondering which value appraisers are seeing Banks lending on and why would they loan on the "as stabilized" value since it's hypothetical and a future value? What would the rationale be for doing that?

 

[Mike Boyd]

If you only loaned on the "as completed" value, it would seem to me it would have to be 100% occupied as you are leaving each office unfinished for the new tenant to decide. However, I'm not a commercial appraiser. By the way, appraisers are normally not included in the loan decision.

 

[Vernon Martin]

Lending 80% LTV on a prospective market value that won't be achieved until 2010 seems like very risky lending. There would be only be about 2.6% equity in the property at the time of completion in 2008. That leaves very little margin for error.

In my own experience, construction lenders tend to base the loan on the prospective market value upon completion, rather than stabilization. What does your bank's regulator say?

VM

 

[Joyce Potts]

I don't mean to come across sarcastic, but if this question even has to be asked given the information in the original post--if you elect to lend 80% of the $2.8 Mil, and you eventually realize a loss, please don't blame the appraiser. And lets not forget that typical 'stabilization' is based on historic data, which in a stable market has a whole lot more credibility than in an transitional, unstable or declining one.

The ultimate call is the bank's. The ultimate consequences (should you take the 'high end' scenario) will have far reaching consequences to your depositors, investors, etc., should the project not reach maximum expectation.

Do the bank officers get bonused or commissioned based on production?

 

[Mr Rex]

I don't mean to come across sarcastic, but if this question even has to be asked given the information in the original post--if you elect to lend 80% of the $2.8 Mil, and you eventually realize a loss, please don't blame the appraiser. And lets not forget that typical 'stabilization' is based on historic data, which in a stable market has a whole lot more credibility than in an transitional, unstable or declining one.

The ultimate call is the bank's. The ultimate consequences (should you take the 'high end' scenario) will have far reaching consequences to your depositors, investors, etc., should the project not reach maximum expectation.

Do the bank officers get bonused or commissioned based on production?

Ya think that might have anything to do with the LO's point of view?

 

[Steve Taylor]

No, the loan officers don't get paid based on commission. I know the loan officer has an interest in getting the loan approved because he has a customer he wants to keep happy and it's a good customer of the Bank. He also feels we have to compete with other Banks and that if other Banks are lending on "stabilized values" and we are not that the business goes elsewhere. Ultimately it looks like it will be up to the loan committee as to how much risk they want to assume and I know the appraiser shouldn't have input into the lending decision and probably doesn't want to. He gave us what we ordered and what the regulations require him to give us. He was just asked by the loan officer what he saw other Banks doing. I just wanted to make sure I wasn't missing something as far as the risk in loaning on "stabilized values". It seemed risky to me and apparently that is the case. It looks like it's coming down to a case by case basis of how long a project will take to get stabilized, how stable the market is overall, how much is pre-leased etc. On this one since the regulation is not clear on it I'm going to recommend loaning on the "as completed" value based on no pre-leases, and an unstable market.

 

[Joyce Potts]

No, the loan officers don't get paid based on commission. I know the loan officer has an interest in getting the loan approved because he has a customer he wants to keep happy and it's a good customer of the Bank. He also feels we have to compete with other Banks and that if other Banks are lending on "stabilized values" and we are not that the business goes elsewhere. Ultimately it looks like it will be up to the loan committee as to how much risk they want to assume and I know the appraiser shouldn't have input into the lending decision and probably doesn't want to. He gave us what we ordered and what the regulations require him to give us. He was just asked by the loan officer what he saw other Banks doing. I just wanted to make sure I wasn't missing something as far as the risk in loaning on "stabilized values". It seemed risky to me and apparently that is the case. It looks like it's coming down to a case by case basis of how long a project will take to get stabilized, how stable the market is overall, how much is pre-leased etc. On this one since the regulation is not clear on it I'm going to recommend loaning on the "as completed" value based on no pre-leases, and an unstable market.

Steven,

While there may not be a direct commision on bonus, clearly all bank lenders get compensated in some, way shape or form based on the deposits and/or the loans made. So clearly, there's still an agenda there.

If your bank decides to loan based on 'stablized' values in order to be more competitive, then that's the lender's call. That said, if the loan heads south , if and when it comes time to liquidate the property to repay the loan back and you find yourself in a deficiency position over and above the costs of and associated with forelcosing, just remember, it was the lender's call.

I think you decision to lend on the 'as completed' figure knowing the market may be showing signs of declining is a sound one.

P.S. Lending and banking regulations are often ambiguious for a reason, IMO. If they were effective, would we being seeing the losses we're seeing in this market?

 

[Joker]

I have some experience in this matter. My lending clients typically lend on the "as completed" value, since that is all that the property will be worth until the tenants complete the interior build out and sign leases for the space. A line of credit can be extended for the difference, to be dispersed as the construction progresses. In no event do they lend on the "as stabilized" value unless in fact, the property has reached that plateau. And my clients are typically more conservative, lending less than the 80% ltv (such as 65%-75%) on commercial property unless there is additional security and a substantially strong borrower. If an appraiser (not me) provides them with only the "as stabilized" value, they work with a 65% ltv.

Although the appraiser uses every piece of available data, economic forecasting of the "as stabliized" value is sometimes a crapshoot. In some instances, the market is expanding rapidly and by the time the appraisal is complete, it is outdated, as the property has signed leases prior to construction. If this is the case for you, there is now the option of lending on the "as stablilized" value, versus the discounted value. Before doing so, I would recommend having the appraiser update the appraisal by reviewing the leases and the interior build out. It would be much cheaper than the original appraisal.

 

[Steve Taylor]

It's a totally spec building (no pre-leases). That's one of the problems I'm having accepting the $2,800,000 number as something we can lend on. I'm now wondering if it is even a feasible project. If the cost is the following:

The purchase of the land and the cost of construction = $2,300,000 + $150,000 in interest carry = $2,450,000 total cost

and the value "as completed" is $2,300,000 then why spend $2,450,000 to get a property worth $2,300,000. I expect the lender's argument would be that it's worth $2,800,000. It looks to me like it won't be worth $2,800,000 for two years after it's completed and then only if it rents up as expected. Am I thinking right?

 

[Fred]

which says in part "For proposed and rehabilitated rental developments, the appraiser must make appropriate deductions and discounts for items such as leasing commissions, rent losses, and tenant improvements from an estimate based on stabilized occupancy."

I think you may be missing the part right after that. It says

For federally related transactions, an appraisal is to include the current market value of the property in its actual physical condition and subject to the zoning in effect as of the date of the appraisal.

I think you are supposed to lend against the "as is" value. The reson for taking deductions for rent loss, TI and occupnacy is to get from complete or stablized value to as-is value.