Facing an Uncomfortable Refinancing Reality

 

The availability of money remains in the open market; the difficulty, though, that owners/borrowers are having is dealing with the severely declining values making refinancing impossible. A condition which cannot be corrected by anything other than a commercial real estate market that appreciates in value — something that will probably not happen for several more years, at the earliest.

Most property owners acquired properties at aggressive cap rates as real estate values increased from 1999 thru 2007. Loans were readily available at 75% to 80% of acquisition price, frequently with an interest-only feature. For instance, $1 million of net operating income valued at a 6% cap rate resulted in a value of $16.7 million and a loan amount (75%) of $12.53 million. Today, net operating is income is most likely 85% of what it was several years ago, $850,000, and current cap rates are 9%, resulting in a current value of $9.44 million. Lenders have become more conservative lending at 60% loan to value ratios, or $5.67 million.

In order to refinance the outstanding loan of $12.53 million, the property owner will need to invest $6.86 million ($12.53 million less $5.67 million) to be able to secure a new loan for this property. Since the property value is currently less than the outstanding loan amount ($9.44 million current value vs. $12.53 million outstanding loan amount), it doesn’t make good business sense for the property owner to invest this additional capital into the property.

The result will be for the lender to take over the property and sell it at current market values, being forced to absorb a significant loss of at least $3 million, assuming no further deterioration in property value. The only thing left for the property owner is a huge tax obligation for his debt forgiveness.

Until the CRE industry accepts the fact that current values are significantly less than past years values, they will continue to blame the lending community for lack of funds. There are loans available from most banks, insurance companies and private funds in today’s environment, but at prudent underwriting standards — which most property owners refuse to accept.

 

Article By: Jeff Chambers, Director, Westcap Corp., Irvine, CA
Source: Watch List Voice: Facing an Uncomfortable Refinancing Reality

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