Meatloaf Would Do Anything For Love But Never Did CRE Lending
The classic rock star Meatloaf once sang “… Two out of three ain’t bad.” Obviously, Meatloaf never did Commercial Real Estate (CRE) lending.
In the second part of this blog series on commercial real estate from Baker Hill and Equifax, the concept of the three unknowns were introduced. We pointed out that in any real estate deal, lenders must research at least two unknowns: the borrower(s) and the property. In a CRE deal, there’s a potential third unknown: existing commercial tenants. But how do you assess and manage the long-term risk of the borrower and the property? Let’s talk about a few best practices that can help to ensure you are not only covering one of the unknown risks, but all three.
Consider the Loan Underwriting.
At the base level, cash flow drives underwriting when you think about most banks and credit unions and how they assess their CRE deals. Bankers perform financial analysis to determine the cash flow produced by their customer’s properties. The debt service coverage ratio is the primary driver, and that, of course, is influenced by amortization and the interest rate (which we spoke to in part one of this blog series) when we discussed how the Fed’s impact on interest rates are changing the CRE landscape. So, one has to ask the question. Are we getting the full view of the cash flow in relation to the borrowers and the associated properties?
If your current loan origination solution is not allowing you to have a global view of the borrowers and their CRE holdings, it is time to consider how you can get those insights. It would be inappropriate to make any credit decision without having this complete view. Additionally, a couple of items to think about when considering cash flow in CRE lending:
- Consider how location and other factors—like a building’s layout—can affect the operations and future potential cash flows of the property.
- Understand how the physical environment of a building realizes (or doesn’t realize) a potential value of the property and the purpose of the loan.
Look at the Collateral Assessment.
One of the benefits of an integrated solution is connecting the valuation with the decision. That is one plus of a LOS like Baker Hill NextGen® where we leverage our integration with LightBox’s Collateral 360. This type of single integration in a solution allows CRE lenders such as banks, credit unions and others to improve the efficiency of their workflow, manage risk, and access data to make important lending and business decisions—all within a secure environment.
You’ve Made the Loan. Now what?
Ask yourself, what steps are you taking to monitor the performance and risks that are associated with not only one single property, but your entire portfolio of CRE loans? Here are a few key points to think about as you look to monitor your CRE portfolio.
- Set and understand clear policies for your CRE loan portfolio. What is the risk that your financial institution is willing to accept without having a massive change in dealing with a CRE borrower?
- Create standards that give you guard rails. Know when you would start to get more involved in an underperforming CRE loan, and even consider options like surrounding property changes and amenities (these can have a huge impact on the valuation), average annual cost swings, and location perception.
- Focus on standardizing portfolio monitoring processes to make decisions easier. Do not create a new rulebook each and every time. Make it systematically efficient versus a manual process.
Thanks again for joining us on this three-part blog with our partners at Equifax as we have looked at the risks, trends and opportunities of CRE lending.
If you would like to keep the conversation going, please reach out to us.
Other blogs in this series:
“Not Knowing” About Commercial Real Estate Tenants Is Not an Option
3 Trends Impacting Commercial Real Estate Lending Today
Posted on Wednesday, December 14, 2022 at 9:15 AM
by Mike Horrocks