eXp Commercial | Chicago Multifamily Brokerage

Monday, April 8, 2024

924 Greenbrier

Just Listed: 24 Unit Multifamily Dekalb
Price: $1,200,000
87.5% Occupancy
Below-market rents
Solid Flexicore Construction
New Boiler/Newer Roof
Resurfaced Parking Lot
Listing Agent: Randolph Taylor
rtaylor@creconsult.net | 630.474.6441

https://www.creconsult.net/dekalb-il-multifamily-property-sale-924-greenbrier/

Friday, April 5, 2024

Understanding Loan-to-Value Ratio (LTV) in Commercial Real Estate

The loan-to-value ratio (LTV) is a common metric used in commercial real estate analysis and computations. LTV is the ratio of the bank's loan amount to the value of the commercial property. It is calculated by dividing the loan amount by the value of the property and expressed as a percentage. In this post, we review the LTV formula, how to calculate it, what its significance is, and how it is used in real estate financing. We include examples of how to use the LTV ratio in calculations.

The Loan to Value (LTV) expresses the ratio of the loan amount to the property value as a percentage. This simple metric is used by appraisers to determine the market capitalization rate or by lenders to determine the size of the loan and to quantify credit quality of existing loans.

The LTV ratio measures the cushion between outstanding loan amount and the property value. Higher LTV implies higher risk for the lender and vice versa. In underwriting, the LTV always appears together with other underwriting metrics such as the debt service cover ratio (DSCR or just DCR) and the debt yield ratio as these determine the feasibility of the financing.

The loan to value (LTV) is the (principal) amount of the loan divided by the property value:

The LTV is expressed as a percentage rate. To calculate the loan amount for a known or given LTV rearranging the formula yields

Lenders use this formula to determine the loan amount for specific financing requirements.

First, a lender estimates the value of the property or hires an appraiser to provide a valuation. This property value is then used in the LTV formula.

As an example, lender determines the LTV for a property appraised at $4,000,000 and a loan amount of $1,000,000 as 1,000,000/4,000,000 = 25%.

In most cases, the LTV is known and we wish to determine the loan amount. Suppose credit policy requires maximum LTV of 75% and the property value is $10,000,000. Here, using the rearranged LTV formula gives 10,000,000 x 75% = $7,500,000 as the loan value.

Bank or lenders typically use the minimum of property appraised value when calculating LTV. For construction or renovation projects, the denominator of the LTV formula includes total project costs instead of just property value. In case the loan is solely to cover construction costs, one uses the loan to cost ratio (LTC) rather than the LTV.

If the LTV ratio equals 100% this means the outstanding loan amount equals the property value. LTV higher than 100% implies the property is worth less than the outstanding loan amount which should not be the case. Contrary, LTV lower than 100% means the property is worth more than the outstanding loan amount.

Lenders require the LTV to be much lower than 100% to have a safety margin. Actual LTVs vary significantly depending on the property type, borrower credit risk, and the bank’s internal credit policy. Usually, LTV ratios range from 40% to 70%.

Now we look at examples of how the LTV is used to calculate the maximum loan amount, how appraiser use LTV to determine the market cap rate, and finally, how to calculate cash-on-cash return using LTV and weighted average cost of capital.

The LTV is commonly used by lenders in a maximum loan analysis which determines the maximum loan amount a lender can support. Here is an example of a maximum loan analysis.

Property Value at 8% Cap Rate is $2,500,000

LTV is 75% -> Max LTV loan is $1,875,000

NOI is $200,000

DSCR 1.25

Allowable Debt Service = $160,000

Max DSCR Loan = $1,719,766

Max Supportable Loan is $1,719,766

The analysis above first calculates a maximal LTV loan as $1,875,000 using the LTV formula. Then, maximal supportable loan is calculated using DSCR, resulting in $1,719,766. Lender would take the smaller of the two values and the maximal supportable loan amount would be $1,720,000 after rounding up.

While appraising, one would often use the LTV in a band of investment calculation, which is a weighted average cost of capital calculation that helps determine the market capitalization rate. In the formula below, Rp is the free return on the property, Rd is return to the debt on the property, and Re is the return on the levered equity in the property, respectively.

$$R_p = LTV times R_d + (1 - LTV) times R_e$$

Appraisers survey local lenders (to extract typical loan terms for subject property) and investors (to find out the typical required cash-on-cash returns) in order to determine overall capitalization rate for a given market and property type.

Example: For the subject property, lenders underwrite loans at 75% LTV, amortized over 25 years, and at an interest rate of 5%. This results in a mortgage constant of 0.07015. Investor surveys show the cash-on-cash return required by most investors is 11%. The over capitalization rate is estimated as:

$$R_p = 75% times 0.07015 + 25% times 0.11 = 8%$$

The above analysis is often used during slow market periods or in tertiary markets where it is hard to find extensive market data.

Employing the weighted average cost of capital formula is also useful to calculate cash on cash returns in case we have insufficient information or data. For this purpose, one rearranges the formula to solve for the return on equity (ROE).

$$R_e = fracR_p - LTV times R_d1 - LTV$$

We can use this formula to solve for cash on cash using LTV, the return on debt, and the return on the property.

Example: Considering the example of the previous section. Note the mortgage constant 0.07015 is our return on debt, and the overall capitalization of 8% is our return on the property. Solving for the cash on cash return on equity yields

$$R_E = frac0.080113 - 75% times 0.07015025% = 11%$$

Hence, LTV ratio together with the mortgage constant and the cap rate can be used in a swift calculation of the cash on cash return.

The loan-to-value ratio is commonly used in CRE and is an integral metric for real estate analysis involving financing and acquisition. This post reviewed the definition of LTV, how to calculate the LTV ratio, and its meaning. We showcased several application of using LTV in calculating maximum supportable loan, the band of investment calculation, and the weighted average cost of capital calculation.

Source: How to use Loan to Value when analyzing a real estate property?

https://www.creconsult.net/market-trends/loan-to-value-ratio-commercial-real-estate/

Understanding Loan-to-Value Ratio (LTV) in Commercial Real Estate

The loan to value (LTV) is the (principal) amount of the loan divided by the property value:

The LTV is expressed as a percentage rate. To calculate the loan amount for a known or given LTV rearranging the formula yields

Lenders use this formula to determine the loan amount for specific financing requirements.

First, a lender estimates the value of the property or hires an appraiser to provide a valuation. This property value is then used in the LTV formula.

As an example, lender determines the LTV for a property appraised at $4,000,000 and a loan amount of $1,000,000 as 1,000,000/4,000,000 = 25%.

The LTV is commonly used by lenders in a maximum loan analysis which determines the maximum loan amount a lender can support. Here is an example of a maximum loan analysis.

Property Value at 8% Cap Rate is $2,500,000

LTV is 75% -> Max LTV loan is $1,875,000

NOI is $200,000

DSCR 1.25

Allowable Debt Service = $160,000

Max DSCR Loan = $1,719,766

Max Supportable Loan is $1,719,766

$$R_p = LTV times R_d + (1 - LTV) times R_e$$

$$R_p = 75% times 0.07015 + 25% times 0.11 = 8%$$

The above analysis is often used during slow market periods or in tertiary markets where it is hard to find extensive market data.

$$R_e = fracR_p - LTV times R_d1 - LTV$$

We can use this formula to solve for cash on cash using LTV, the return on debt, and the return on the property.

$$R_E = frac0.080113 - 75% times 0.07015025% = 11%$$

Hence, LTV ratio together with the mortgage constant and the cap rate can be used in a swift calculation of the cash on cash return.

Source: How to use Loan to Value when analyzing a real estate property?

https://www.creconsult.net/market-trends/loan-to-value-ratio-commercial-real-estate/

Thursday, April 4, 2024

NAR's $418M Settlement's Real Estate Commission Impact

Fallout from the National Association of Realtors' settlement of a $418M antitrust lawsuit earlier this month is set to profoundly shake up the residential real estate industry and how it does business.

But commercial brokers, attorneys and policy watchers are greeting what amounts to potentially earth-shattering changes in commission structure on the residential side with a general shrug of the shoulders, despite a few exceptions that pertain mostly to condo sales and crossover agents who dabble in commercial real estate deals that turn up on multiple listing services.

“I don’t think it’ll change the big picture on the CRE side,” said Shams Merchant, a Fort Worth-based real estate attorney with Jackson Walker, pointing out the fact that commercial transactions have always been different than residential sales, with commercial landlords and sellers free to negotiate commissions with buyers or tenants' brokers as an incentive to lease or sell a property.

On CRE's side is the fact that “there’s no industry standard” to spark antitrust concerns and no organized clamor to do so, Merchant said.

In mid-March, NAR agreed to pay $418M in damages over four years to settle lawsuits levied by home sellers who argued the organization's longstanding rules on broker commissions resulted in excessive fees. As part of the settlement, NAR said it would revisit its standard 6% sales commission fee for residential Realtors in a move some real estate observers said would “blow up the market” for brokers that are among the world's best-paid.

The rule changes from NAR’s settlement will ban it from allowing a seller’s agent to set compensation for a buyer’s agent, remove commission information from multiple listing services, no longer require agents to subscribe to MLS and mandate that buyer agents enter into individualized buyer-broker agreements with clients.

Researchers say the shift could result in Realtors’ commissions falling by as much as 50% annually and up to 2 million U.S. agents leaving the field. But commercial real estate brokers and transactions likely won’t be impacted to a significant degree, according to experts who spoke to Bisnow.

“We deal directly with our clients on listings, so we’re not using the MLS,” said R.J. Jimenez, an Oklahoma City-based industrial broker with NAI Sullivan Group. “The software we use isn’t proprietary to Realtors only, so I think that’s what helps out.”

What's more, Jimenez said, no agency holds a monopoly on commissions in the commercial sphere. In the aftermath of the NAR settlement, Jimenez launched a social media thread asking brokers if they anticipated any changes on the commercial side due to the settlement.

Answers ranged from “It doesn't” to “We get paid based on how much value we bring to the sale. Not whether the buyer likes the pool and kitchen.” Some speculated the rules change could prompt more residential agents to move over to the commercial side, while others tossed doubt on that idea, saying that “good selling agents will educate their seller on paying a buyers agent so as to not reduce that buyers pool that cannot afford to pay for their agent.”

While the fallout may push some Realtors out of the profession, it's unlikely that they'll move in droves to the commercial real estate sector because they're just so different, sources told Bisnow.

It takes years of consistency for commercial brokers to get to a place where deals are regularly happening, while many residential agents do real estate part-time or as a side job, Merchant said.

“You can’t do that on the commercial side," he said. "It’s a full-time job."

Since the settlement announcement, NAR has stressed that it does not set commissions, only requiring that listing brokers communicate an offer of compensation. But most U.S. agents specify a commission of 5% or 6%, according to the New York Times, leading to the antitrust charges.

The impact of the NAR settlement on day-to-day CRE exchanges is expected to be minimal, but the lawsuit could potentially seep into some limited segments, Merchant said.

“The mom and pop owners who own one or two properties might be more reluctant now to pay the tenant broker’s commission,” he said.

Those types of property owners don’t have as much capital to pay out tenant brokers’ commissions, and the NAR lawsuit shows them they don’t have to. That could lead to more tenant brokers entering into exclusive representation agreements with their tenants, he said. Those agreements would specify that if the landlord does not cover their commission, the tenant will, he said.

“This is common, but it may become more common going forward,” Merchant said.

In addition, residential Realtors are already sometimes involved in commercial transactions and will have to shift to abide by NAR rules, said Ed DiMarco, a Realtor based in Naples, Florida.

DiMarco, who sometimes works with small-to-midsize commercial property transactions, said that he would always choose to be a member of NAR. Naples has a smaller commercial market, and most listings are on an MLS, he said.

“I probably find more [of my] listings on the actual MLS managed by the National Association of Realtors,” DiMarco said. “They've also been going after commercials for over a decade now, real hard, and they have some great tools.”

The lawsuit settles what DiMarco has always seen as a conflict of interest. A broker’s expectation to be paid by the seller rather than their own client can make them partial to the seller, he said. DiMarco has always done buyer agreements for that reason, no matter what the seller might be offering.

“Now it’s going to be standard, and I think that will also help a lot of agents … who have been afraid to ask for them because you can always find agents that don’t require them,” DiMarco said.

In smaller markets like his, Realtors are often involved in commercial transactions, DiMarco said, adding the NAR lawsuit outcome will absolutely impact commercial brokers commissions, an argument he outlined in a LinkedIn blog post.

The lawsuit will also impact developers of residential condo towers, like those represented by Preston Patten, an Austin-based shareholder and attorney at Winstead law firm. If a buyer of a residence has a broker, they will likely have more upfront cautionary measures and paperwork, he said.

But for office, industrial, and other commercial asset classes, Patten said he doesn’t expect much change.

“It will be business as usual from my perspective,” he said.

One company that handles residential listings might be set to benefit from the lawsuit's fallout, however. CoStar’s stock price rose 8% on March 20, the same day that the settlement news broke.

CoStar’s Homes.com does not sell homebuyer leads to buyer’s agents, instead providing them free to the property’s listing agent, theoretically insulating it from effects on buyer agents that the new rules impose, according to YahooFinance. CoStar did not immediately respond to a request for comment.

Homes.com doesn’t monetize buyer agency and take a portion of agent’s commissions like its competitors do, CoStar said in an investor slide deck, according to YahooFinance.

“I do think CoStar is in a position as it stands, depending on how they play their cards, to get ahead of the game with this move,” DiMarco said.

But players in the commercial world at firms like JLL and CBRE are very sophisticated and specialized, so their processes will remain the same, Merchant said.

“In commercial, we’ve always done it differently anyway. The seller broker never had to upfront set the commission like they did in residential,” he said. “That was the whole lawsuit. They would have to set the commission up front and provide it through the MLS. We’ve never done that in commercial.”

Source: Landmark NAR Settlement Could Impact A Handful Of CRE Deals, But For Most, It’s ‘Business As Usual’

https://www.creconsult.net/market-trends/nar-antitrust-settlement-impact/