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Trends in Commercial Real Estate Valuations

Commercial loan administration today is a much more complicated process than in the past, especially when applied to commercial real estate loans. Valuing the underlying real estate requires more careful analysis.

In the past, some lending portfolio managers would simply ensure that a property’s new net operating income is adequate to meet their bank’s debt service coverage ratio requirement. More detail oriented lenders might even go as far as to recalculate the property’s value based on an updated NOI and a market capitalization rate.

Today, though, good commercial loan administration requires a much deeper look at a property and its operations. Astute managers will carefully analyze a property’s rent roll and go well beyond simply calculating NOI. To begin with, they will assess each tenant’s likelihood of remaining in the property and their ability to meet their obligations. The next step is to carefully analyze the rent levels to ensure that they are replaceable in the market. For example, if a tenant has two years remaining on a lease at $27 per square foot when the market is now $18 per square foot, the building is likely to lose income in a couple of years.

Paying attention to these factors and building property valuations that take

future changes into effect can make a significant difference in a bank’s bottom line. Knowing what is likely to come down the line can help credit departments position themselves for work outs with borrowers or, if necessary, conserve capital to increase their reserve accounts.