[shaftway]

Not if the economy actually does recover, or at least "looks" like it recovered on paper. Inflation helps with that.

The average inflation over the last 10 years has been just north of 3%. If you have tenants today that are paying $500k/year, in 10 years they should be paying almost $700k/year with 50% occupancy. If you can string the bank along for another loan then your valuation is $28M instead of $20M. As the owner you can effectively take money out in this scenario.

If the bank won't refinance at that rate, then you could lower your rents by a bit in the last year. If you lowered your rates back down to $500k/year then you invite a bunch of new tenants, and now you can show high occupancy again.

[AnthonyMouse]

But how does it help the bank to require that? Suppose the landlord lowered rents to raise occupancy so they could get $700k now instead of after several years of inflation. If all goes according to plan then the bank gets its interest payments either way, and then the landlord would be making $900k with full occupancy instead of $700k with half occupancy.

But if the value doesn't recover then the landlord is still only getting $500k while paying $640k at the point when they run out of money to pay their $140k annual loss, and then they default. Which they wouldn't do, even if the value never recovers, if they were allowed to make $700k by lowering rents.

[Nevermark]

The problem is the bank didn’t leave a buffer to meet their requirements, so arbitrage between reality and official reality comes to the rescue.

If a bank only loaned 60% of a buildings value, it could be devalued, the operator would eat the shortfall, but the bank could reappraise, with the loan continuing as before.

[So a regulation setting a banks maximum loan percentage, at a percentage less than they are required to maintain, is an obvious regulatory fix.]

However, another way to look at this from a banks point of view is while they may loan 80%, they might have been happy to loan 100% but for regulations. So perversely, they may not be as concerned about this happening as it appears.

For them, the 80% max loan is already providing a buffer, in terms of the risk they would be happy to take. So if they can avoid acknowledging they have loans that have risen in percentage terms, it is in their business interest to encourage, facilitate, giving operators breathing room.

And in the meantime, inflation, property value growth, and future demand increases provide three statistically “expected” ways for the situation to self-correct over time.

For financial investment products, all value is “expected” value.

And the operator may not be losing money, so much as paying for the buildings accrued value growth. Which would be a wash, but avoids the practical problems of defaults. Not the best, but not losing (as much) money as it appears.

And for the bank, if the loan payments are made there is no problem.

So there are two hidden buffers: banks willingness to loan more than regulators want them to, and natural property value increases, lowering rent prices (i.e. inflation) over time.

[AnthonyMouse]

> The problem is the bank didn’t leave a buffer to meet their requirements

They did though. It was a $20M building and they only loaned out $16M, providing a $4M buffer. It isn't possible to require an amount that the value of the building could never fall below under any circumstances because that would require the loan amount to be zero. It's always possible for the value of the property to crash, e.g. it becomes contaminated with toxic waste and the remediation costs more than the property value, or the area's major employer shuts down and the area becomes a ghost town.

Meanwhile increasing the size of the buffer has costs that can exceed the value of a larger buffer, i.e. fewer people can afford a mortgage, which is both economically bad and not in the interests of the bank who wants to make more loans rather than fewer.

> However, another way to look at this from a banks point of view is while they may loan 80%, they might have been happy to loan 100% but for regulations.

The reason banks require a down payment instead of loaning out 100% of the value of the property is definitely because the banks want the buffer to not be zero.

> And for the bank, if the loan payments are made there is no problem.

But that's the issue. If they prevent the landlord from lowering rents to increase occupancy then they may not be able to make the payments anymore, and then the bank is screwed.

[Nevermark]

> They did though. It was a $20M building and they only loaned out $16M, providing a $4M buffer

The problem is the bank is regulated to only maintain loans at 80% of property value or lower.

If they give a loan at the maximum allowable level, they don't have a (legal) buffer.

Thus the strong incentive to perform creative bookkeeping, to avoid having to repossess property they don't want. Instead of simply recognizing the falling property value in their accounting, which without a forced call, is the property owners loss, not theirs.