| Borrowers can now more easily observe that the | | | | maximum loan proceeds offered by Commercial |
| higher the cap rate used, the lower the | | | | Properties. In the current commercial real estate |
| underwritten value. What the lenders are analyzing | | | | market where cap rates remain at forty-year |
| is how to capitalize the net operating income. | | | | lows, lenders find themselves in the precarious |
| After analyzing the income and expenses on a | | | | position of addressing the sometimes vast |
| property and then arriving at a net operating | | | | disconnect between low cap rates and weak real |
| income (NOI), lenders must then determine what | | | | estate fundamentals. |
| type of return on the investment should that NOI | | | | When striving to reach the full loan dollars sought |
| be representative of. Riskier projects are typically | | | | by borrowers, lenders are conflicted with the idea |
| subject to higher underwritten cap rates and vice | | | | of using market cap rates or artificial cap rates. |
| versa. By using a higher underwritten cap rate or | | | | Market cap rates are cap rates that can be |
| in other words a higher rate of return , lenders | | | | supported using data from other transactions |
| are thereby decreasing the value of the project in | | | | currently taking place or recently achieved in the |
| accordance with the type of return the lender | | | | marketplace. Note however, that just because a |
| feels an investor should be receiving given the | | | | certain cap rate is achieved in today's market |
| risks and rewards of the project. | | | | that that is not necessarily an indication of the cap |
| Lenders have very strict leverage constraints. | | | | rates to be achieved in the marketplace at |
| Typically lenders, Commercial Properties, will lend a | | | | various points throughout the loan term. If you |
| maximum of approximately 75%, and at times | | | | recall from the discussion above that compares |
| 80% of underwritten value. Therefore it should be | | | | the two types of Income Capitalization Approach, |
| clear that when lenders underwrite a loan using a | | | | the Direct Approach, which is the most commonly |
| higher cap rate, thereby decreasing the | | | | used of the two, only kicks out a single NOI |
| underwritten value of the asset, that the | | | | figure. Therefore, unlike the Indirect Approach, |
| maximum loan amount offered will likely be | | | | which can account for specific, future annual |
| reduced. Although, Commercial Properties | | | | adjustments in the NOI analysis, the single NOI |
| approach the valuation analysis using the same | | | | derived using the Direct Approach must be |
| basic methodology, the Income Capitalization | | | | representative of the average of what is |
| Approach, it is important for Borrowers to | | | | expected to take place over the life of the loan |
| understand that the underwriting cap rate may be | | | | term. And therefore the cap rate applied to the |
| substantially different than the market cap rate | | | | NOI in the Direct Approach must also take on |
| (the cap rate properties are currently trading | | | | that same philosophy. That should through the real |
| hands at in the market). This can be a difficult | | | | estate loans. Therefore, in order to sell (securitize) |
| concept for some Borrowers to get their arms | | | | the loans successfully there has to be sufficient |
| around but it is the foundation to understanding | | | | evidence that the loans can support the coupon |
| how there can be such a big disparity in | | | | payments promised to the bond investors. |