[lotsofpulp]

>Those loans often do not allow the borrower to charge lower rent.

I have never seen it substantiated that a promissory note in commercial real estate has a clause that dictates how the borrower can price their products or services.

There will be terms for the borrower to be in default if they lose too much revenue or their expenses go up too much, such as leaving spaces empty:

https://www.investopedia.com/terms/d/dscr.asp

Whether a lender wants to foreclose on a borrower in default is far from guaranteed. Often times, they are loathe to take over management of a building so they simply work out a new agreement with the borrower.

[bruce511]

No there won't be clauses about rental amounts. It's not that straightforward.

It boils down to collateral for the loan.

A building has a value based on future rents. The owner borrows from the bank based on that value. The building is collateral for the loan.

The rental rate (not occupancy) determines the current building value. (Occupancy affects cash-flow, but not building value.)

Reducing rent improves cash flow, which may help paying the loan, but loan payments here are not important.

What is important is that the collateral covers the loan. Reducing the rent triggers a re-evaluation of the building value, which in turn affects the loan. There's no discretion here, it's just math.

On the other hand, as long as the owner continues to pay the installment on the loan, and as long as the building remains the same value, the banker doesn't have to do anything.

Yes, there are ways the price can be fudged a bit (bundling services, remodeling allowances and so on) but the "list price" of the rent can't come down without (automatically) triggering loan problems.

Since property companies tend to have multiple properties, cash flow is sufficient to pay the loan. So that's a lot better than triggering a revaluation.

In short commercial real estate does not behave like residential real estate.

[bombcar]

This is exactly the key - residential real estate is based on tons of pricing effects, and appraisals are much more "feels" than "reals", if you will (how people feel about the area, how they feel about the tower the previous owner added, how they feel about the location, etc).

Commercial real estate valuations are almost entirely a mathematical formula based on rents, current, whether they're collecting them or no. And if the rents drop (e.g., you start renting it at a lower square foot rate) the valuation drops, which can require recollateralization (e.g., unlike your house, the banks require that the loan NEVER be more than 50% LTV or something) so if the value of the property calculation makes it go above that, you have to pay down the loan or add additional property as collateral.

[lotsofpulp]

Residential real estate has a lot of sweetheart terms due to government subsidies, especially in the US. That is why you don’t see 30 year fixed rates anywhere else, and 0% down loans anywhere else.

The DSCR equivalent for residential real estate is debt-to-income ratio. In a free market, it is conceivable that lenders offer lower interest rates for borrowers who periodically prove their DTI is sufficient. That is basically what refinancing is, and what people with adjustable rates mortgages have to do.

> residential real estate is based on tons of pricing effects, and appraisals are much more "feels" than "reals",

If you have looked at a residential real estate appraisal, there is a very real process of gathering comps, evaluating the structure, discounting for wear and tear of major maintenance items such as roof, HVAC, etc. If anything, because residential real estate sales volume is so much higher than commercial, residential is more “reals” than “feels”.

> if you will (how people feel about the area, how they feel about the tower the previous owner added, how they feel about the location, etc).

Who are these “people”? Because if we are talking about appraisers, this should disqualify their license to appraise. Appraisers should be mostly looking at competitive sale prices, per sq ft construction costs of major house components, and other objective criteria. Why else would a lender pay them to evaluate a property?

>Commercial real estate valuations are almost entirely a mathematical formula based on rents, current, whether they're collecting them or no

This is not true. Try calling up a lender and asking to borrow money without showing them cash flow, and they will hang up on you.

> And if the rents drop (e.g., you start renting it at a lower square foot rate) the valuation drops, which can require recollateralization (e.g., unlike your house, the banks require that the loan NEVER be more than 50% LTV or something)

They literally do this, via DSCR. If you stop renting space, your operating income goes down, which causes the DSCR to go down, which triggers a default, which means the lender can negotiate new terms, which could involve the borrower putting up more money, extended loan terms, change in interest rate, anything.

The alternative to a loan with a DSCR is usually a 5 year adjustable rate mortgage, which usually has a higher interest rate and then in 5 years, you still have to use your cash flow to qualify for another loan, so eventually someone will want to see income for the property

This is a good guide:

https://www.occ.gov/publications-and-resources/publications/...

On page 21, for underwriting standards:

> Effective CRE lending policies generally reflect the following for each type of loan or property:

>• Minimum standards for borrower or project net worth, support provided by guarantees (if applicable), borrower and guarantor cash flow, and debt-service coverage ratio (DSCR).

[aardvarkr]

Residential real estate appraisals are done by under employed real estate agents. They’ll always find a way to justify the number that you paid, like during Covid when I bid $200k over asking for a $1M house, the appraiser didn’t bat an eye and got to that number. That was totally based on vibes.

[lotsofpulp]

I don’t know what “under employed real estate agents” means, but the appraiser that the lender cares about is in no way associated with the real estate agents. The lender picks the appraiser (a licensed professional usually working as an independent contractor) who submits a report to the lender, who then determines whether or not they want to use it.

Asking price also has nothing to do with market value, so offering $200k more over asking would be irrelevant to the appraiser. You should have received a report showing recently sold houses similar to the one you were buying and other physical features that justified the appraisal.

There is even an appraisal contingency in most purchase agreements that outline what to do if an appraisal comes in lower than what a buyer offers to pays. Typically, the buyer can exit the purchase and get their earnest money back, or they can put additional money down to cover the gap between the appraisal and the offer price.

[consensus1]

If a house is getting so many bids that it sells for 200K over asking, then that is pretty clearly the market price as determined by auction. Of course the appraisal would sat that is the value because it is.

[consensus1]

This sounds like a conspiracy theory. Why would a bank be willing to accept a valuation based on a fictional rent number?

[lotsofpulp]

> Reducing the rent triggers a re-evaluation of the building value, which in turn affects the loan. There's no discretion here, it's just math

What is “the” rent? The building has multiple tenants (usually), at various prices. It makes no sense that there is a specific price that the landlord cannot rent at to any one tenant that “triggers” a re-evaluation.

If the lender wants a continuous view into the collateral’s value, which any lender with two brain cells to rub together would, then it would require a minimum DSCR, which they do.

https://www.investopedia.com/terms/d/dscr.asp

>On the other hand, as long as the owner continues to pay the installment on the loan, and as long as the building remains the same value, the banker doesn't have to do anything.

This is not sufficient for most CRE loan covenants.

https://www.cohenandsteers.com/insights/the-commercial-real-...

> And 75% of CMBS office loans have a debt service coverage ratio (DSCR) greater than 1.5x (Exhibit 9). This helps to mitigate the risk of term default (i.e., a default prior to a loan’s maturity) since the net cash flow on the properties sufficiently covers interest payments. Generally, term default risk is more of a concern when the DSCR falls below 1.25x. But only 15.5% of CMBS office loans currently have a DSCR in this range.

> Yes, there are ways the price can be fudged a bit (bundling services, remodeling allowances and so on) but the "list price" of the rent can't come down without (automatically) triggering loan problems.

>Yes, there are ways the price can be fudged a bit (bundling services, remodeling allowances and so on) but the "list price" of the rent can't come down without (automatically) triggering loan problems.

DSCR cannot be fudged this way, without engaging in fraud. That’s the whole point, looking at cash flow for the specific collateral gives the lender insight into how well the collateral is being managed and market conditions.

>Since property companies tend to have multiple properties, cash flow is sufficient to pay the loan. So that's a lot better than triggering a revaluation.

Nothing I am reading indicates this is the case. The idea that lenders would want to pretend a business is fine just because they stop selling rather than sells at a lower price than at some point in the past is not passing the smell test. If lay people on the internet can figure out the folly in this concept, then surely the people betting millions and billions can.

[twoodfin]

The discourse about commercial real estate in downtowns (well-beyond this thread) has taken on a kind of “one neat trick” wishful thinking.

If only the greedy owners or banks would recognize their massive investments had lost hundreds of billions in value due to declining demand, then… the underlying causes of that decline in demand and the consequences if it persists can be waved away?