The Valuation Quagmire

As commercial real estate enters the second year of its downward slide a new problem is arising for many commercial borrowers. Valuation!

Because of the down economy many business have failed and left large swaths of commercial, retail and office space vacant. The large numbers of vacancies are causing the value of current leases for some industries to be discounted and is pushing down the rent per square foot of available space.

This downward spiral is affecting Values which exacerbates a larger problem. Many loans are entering their 'call' period. A call is where a loan is reevaluated to determine if it still meets the lender's original standards and guidelines.

If the property does not meet the lenders guidelines for gross and net revenues and for it's LTV requirement then the loan is 'called' due. The problem facing many with commercial loans on real estate is this.

While they may be making their payments on time, the Loan to Value ratio (LTV) and the Debt Service Coverage Ratio (DSCR) are way to low. The loans will be called 'due' even though their payments are on time.

This impending foreclosure deluge could flood the market this summer. The only thing that will stop it is if the government is successful at restarting the Commercial Mortgage Backed Securities (CMBS) market that collapsed last year.

Another factor that could help is if the government loosens the regulations on TALF (Troubled Asset-Relief Fund) and allows the fund to start guaranteeing some of these underwater assets. Whatever happens, there are sure to be some opportunities for savvy investors.

Now may be the time for real estate investors with large residential portfolios to consider liquidating some of those assets to take advantage of the new opportunities that will be available in small commercial.