Risk Management for Commercial and Investment Real Estate Secured Loans
Commercial and investment real estate (office, industrial, retail, multifamily residential, and special purpose) is the backbone and primary source of collateral for most banking institutions. That’s why secured loans for commercial and investment real estate need to be closely monitored, as values can change dramatically with small changes in cash flows.
Compliance & Collateral Examination Services help this asset sector by reviewing and analyzing the three major components that influence value:
- Revenue (marketing)
- Expenses (management)
- Finance (working capital)
Compliance & Collateral Examination Services determines if:
- The property is worth the collateral value assigned.
- The condition of the real property is suitable for its intended use and that it is properly maintained.
- Reported cash flows generated from the real property are correctly stated.
- Real property values are supported by comparable properties sold or leased in the market.
- Real property values are supported by the income approach.
Revenues are the result of marketing efforts that provide the cash inflows. We will consider:
- Is the revenue source(s) marked to market?
- Is the marketing of the property generating market leads and capturing sale or lease contracts?
- What type of lease is securing optimal rents (gross, net, hybrid)?
- What type of escalators are employed (step, CPI, percentage rents)?
- Are all rents, charges, and reimbursements accounted for, appropriately calculated, charged, and collected?
- Are appropriate rent clauses included in the leases to protect the income stream (use clauses, exclusive clauses, “go dark” clauses)?
- Are collection efforts effective?
- Are accounting procedures adequate?
- Are management follow-up procedures adequate?
- Testing of revenue collection days, deposit days, etc.?
- Do rents and other collections reconcile to revenue receivables and bank statements?
Expenses are management operations required to service the property and maintain the revenue stream. We will consider:
- Are CAM charges appropriately calculated and charged?
- Are tax and insurance charges appropriately calculated and charged?
- Are expenses reasonable and competitively bid?
- Is the property properly maintained?
- Is there any deferred maintenance issues (building, roof, parking lot, and grounds)?
- Are there any environmental concerns?
- Are all taxes and fees current?
- Are there any insurance hazards?
- Are vacancies market ready?
- Are lease obligations properly managed (insurance binders collected and is owner additionally insured)?
- Expense audits?
- Are contractor files properly managed (i.e. are worker comp and insurance certificates collected, are warranty and guarantees in place, etc.)?
- Are inventory files complete and current?
- Are employee files complete and current?
- Expense audits?
- Vertical and horizontal analysis?
Financing deals with managing cash flow to maximize return on the property. We will:
- Review existing financing terms and conditions.
- Review cash requirements for the short-term needs, deferred maintenance needs, and capital improvement needs.
- Determine financing options and terms to maximize property values and cash flow needs.
- Calculate the cash flows, IRR, and NPV of different capital expenditure opportunities.
- Conduct a Broker Price Opinion (BPO) to establish market value.