Opportunities in Real Estate

Where are we in this cycle?

Risk Pendulum

Risk Pendulum

Lower Risk

Higher Risk

Moderate Risk

Loan Sizing

Wells Fargo is a cash flow lender

Focuses on the amount of debt that can be supported by the net operating income
(NOI) of the property over a long term horizon

CmBG uses a mortgagability analysis

Fundamental tool to size a loan
Assumes a mortgage constant* of 10% (8.91% interest rate, 25 year amortization)
Mortgage Constant of 10%
Amortization
InterestRate
30years
9.40%
25years
8.91%
20years
7.95%
15years
5.81%
12years
3.12%

*The ratio of annualized rate of interest

and principal paid by the borrower per
annum to total current loan principal
outstanding.

Required DSC Ratio

Three Main Tenets of Real Estate Underwriting

1. People
Do we know the people?
Track record
2. Credit
Financial Capacity
Others in the deal
Lending Strategy

Credit

Real Estate

3. Real Estate
Building Specifics
Surrounding Area
Occupancy/Vacancy
Cash Flow
Valuation
Where are we on the risk pendulum after analyzing these tenets?
4

Loan Structuring
Facility Type
Loans are primary segmented into three categories.
Term Loans
Stated beginning balance with specific repayment terms
Maturity is typically 3, 5, or 7 years based on the nature of the asset
Reducing Revolver
Secured typically by multiple asset
Facility may be draw up and down multiple times
Principal amount available to the client reduces over time
Construction Loan
Funded up during the construction to pay the hard and soft costs
At the end, a certificate of occupancy (CO) is issued confirming the building is complete
The loan is then typically termed out

Net Operating Income

Net Operating Income (NOI) = Annualized Rental Payments + Reimbursements (if any)
Operating Expenses associated with the property

Gross income includes both rental income and other income such as parking fees, expense
reimbursements, etc.

Operating expenses are costs incurred during the operation and maintenance of a property
Repairs and maintenance
Insurance
Management fees
Utilities
Supplies
Property taxes, etc.
The following are not operating expenses
Principal and interest
Capital expenditures
Depreciation
Income taxes
Amortization of loan points.

Net Operating Income

Gross Rents Possible

$1,000,000

Other Income

Rents: can be quoted on

a, Net or NNN basis
where the tenant is
responsible for part or all
operating expenses. Rents
may also be quoted on a,
Gross basis where the
Landlord is responsible for
the operating expenses.

$100,000

Potential Gross Income

$1,100,000

Less Vacancy (10%)

($110,000)

Effective Gross Income

$990,000

Less Operating Expenses

($120,000)

Net Operating Income

Vacancy/Credit Loss is
typically reflected at the
greater of actual or
market vacancy.

$870,000

Operating Expenses review of historical

operating expenses and a
comparison to market
expenses are important to
understanding stabilized
NOI.

Debt Service Coverage Ratio

Debt Service Coverage Ratio (DSCR) = Annual Debt Service (Actual Interest + Principal
Payments)

Non-cash items should be excluded (i.e. depreciation and amortization) from the calculation of NOI
Expenses should also include a capital reserve item (for loans on our balance sheet we generally dont
take these as reserves)

Expenses should also be the greater of actual or market and in almost all cases include a management
fee even if the borrower self-manages and doesnt charge a fee

When using DSCR as a metric, please identify the following

Interest rate
Amortization schedule
Amortization method (mortgage style or straight line)

Common Real Estate Ratios

Cap Rate = Yearly Income/Total Value
The process of converting the income from a property into an expression of capital value.
This is the rate of return on R/E based on the expected income of the property
Also referred to as the Investors Rate of Return

Debt Yield = Annual NOI/Loan Amount

The debt yield indicates the NOI as a percentage of the total loan amount
Typically 10% is used but the rate can go as high as 11% or 12% in a volatile market

Mortgage Constant = Annual Rate of Interest + Principal Payments per year/Total Current
Loan Outstanding
The mortgage constant is a rate that reflects the periodic annual payment of principle and interest on a
mortgage with a level amortization schedule that will extinguish the debt.
The Mortgage Constant changes when the interest rate and amortization schedule changes
Mortgage Constant of 10%
Amortization
InterestRate
30years
9.40%
25years
8.91%
20years
7.95%
15years
5.81%
12years
3.12%
9

Sustainability of Cash Flow

S q u a re F e e t
1 0 0 ,0 0 0
G r o s s P o te n tia l R e n ts
C A M R e im b u rs e m e n ts
T a x R e im b u rs e m e n ts
In s u ra n c e R e im b u rs e m e n ts
O th e r In c o m e
T o t a l G ro s s R e v e n u e s
V a c a n c y a n d C o lle c tio n L o s s ( 1 0 % )

R e ta il
C e n te r

C o m m e rc ia l
B u s in e s s

$ 1 ,7 0 0 ,0 0 0
$ 3 0 0 ,0 0 0
$ 1 0 0 ,0 0 0
$ 7 0 ,0 0 0

S a le s
O th e r In c o m e

$ 1 5 ,0 0 0 ,0 0 0
$ 5 0 0 ,0 0 0

$ 2 ,1 7 0 ,0 0 0

T o tal R e v e n u e s

$ 1 5 ,5 0 0 ,0 0 0

$ 2 1 7 ,0 0 0

C O GS

$ 6 ,2 0 0 ,0 0 0
$ 9 ,3 0 0 ,0 0 0

E ffe c tiv e G ro s s I n c o m e ( E G I )

$ 1 ,9 5 3 ,0 0 0

G ro s s M a rg in

O p e ra tin g E x p e n s e s

$ 5 7 3 ,0 0 0

O p e ra t in g E x p e n s e s

$ 5 ,0 0 0 ,0 0 0

N e t O p e ra t in g I n c o m e (N O I )

$ 1 ,3 8 0 ,0 0 0

E B IT D A

$ 4 ,3 0 0 ,0 0 0

V a lu a tio n
C A P R a te
V a lu e

$ 1 ,3 8 0 ,0 0 0
8 .0 %
$ 1 7 ,2 5 0 ,0 0 0

V a lu a tio n - 5 x c a s h F lo w
C a s h F lo w M u ltip le
E n te rp r is e V a lu e

$ 4 ,3 0 0 ,0 0 0
5 x
$ 2 1 ,5 0 0 ,0 0 0

M a x A llo w a b le D e b t
LTV
C a s h f lo w M u ltip le

$ 1 2 ,9 0 0 ,0 0 0
75%
1 2 .5 x

M a x F u n d e d D e b t to C a s h F lo w - 3 x
LTV

$ 1 2 ,9 0 0 ,0 0 0
60%

Stable Cash Flow is Key - Understand the current and future cash flows

Net Operating Income (NOI)

Real Estate typically is valued on a Cap Rate, where business are valued on Cash Flow Multiple
An 8% cap rate is equivalent to a 12.5x cash flow multiplier.
In other words, for every $100M decrease in free cash flow is equivalent to $1,250M in
value. A small change in NOI can have a material impact on implied value.
10

Loan Sizing: Mortgage Constant

(A)
Interest Loan Mortgage
Rate Amo Constant
4.00%
4.50%
5.00%
5.50%
6.00%
6.50%
7.00%
7.50%
8.00%
8.91%
9.00%
9.50%
10.00%
10.50%
11.00%
11.50%
12.00%
12.50%
13.00%

300
300
300
300
300
300
300
300
300
300
300
300
300
300
300
300
300
300
300

6.33%
6.67%
7.02%
7.37%
7.73%
8.10%
8.48%
8.87%
9.26%
10.00%
10.07%
10.48%
10.90%
11.33%
11.76%
12.20%
12.64%
13.08%
13.53%

(B)
NOI
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000

(C)
(D)
Min
$ For
DSC Debt Serv.
(B)/(C)
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000
1.25x $200,000

(E)

(F)

Constant
Carried

Loan
(D)/(A)
$3,157,541
$2,998,505
$2,851,001
$2,714,054
$2,586,781
$2,468,378
$2,358,115
$2,255,327
$2,159,409
$2,000,700
$1,986,027
$1,907,603
$1,834,121
$1,765,197
$1,700,484
$1,639,663
$1,582,443
$1,528,555
$1,477,757

LTV

(Debt Yield)

75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%
75.00%

(B)/(E)
7.92%
8.34%
8.77%
9.21%
9.66%
10.13%
10.60%
11.08%
11.58%
12.50%
12.59%
13.11%
13.63%
14.16%
14.70%
15.25%
15.80%
16.36%
16.92%

11

(G)

(H)

Value
Cap Rate
(E)/(F)
(B)/(G)
$4,210,055
5.94%
$3,998,007
6.25%
$3,801,334
6.58%
$3,618,739
6.91%
$3,449,041
7.25%
$3,291,171
7.60%
$3,144,153
7.95%
$3,007,103
8.31%
$2,879,212
8.68%
$2,667,600
9.37%
$2,648,036
9.44%
$2,543,471
9.83%
$2,445,494 10.22%
$2,353,596 10.62%
$2,267,312 11.03%
$2,186,217 11.44%
$2,109,923 11.85%
$2,038,074 12.27%
$1,970,343 12.69%

Loan Sizing: Debt Yield

Debt Yield can be used to size a loan
To size a loan to a 12.5% Debt Yield for investor real estate
Divide by Constant Carried (10% mortgage constant * 1.25x)
To size a loan to 11% Debt Yield for Owner Occupied
Divide by Constant Carried (10% mortgage constant * 1.10x)
To quickly size a loan, take the estimated NOI and divide by required debt yield
Notice, on high cap rate properties such as a hotel, the 12.5% debt yield may not be enough of a factor to size
a loan.

What would be the required Debt Yield if you wanted to be at 65% LTV on a hotel?

HowdoweEstimateSupportableLoanAmount?
Apartment
NOI
Debt Yield (12.5%)
Supportable Debt
Estimated Cap Rate
Value
EstimatedLoantoValue

Industrial

Office

Hotel

$1,000,000

$1,000,000

$1,000,000

$1,000,000

12.50%

12.50%

12.50%

12.50%

$8,000,000

$8,000,000

$8,000,000

$8,000,000

6.00%

8.00%

9.00%

10.00%

$16,666,667

$12,500,000

$11,111,111

$10,000,000

48.00%

64.00%

72.00%

80.00%

12

Case Study Exercise 1

Deal Summary

Existing customer that we know well and want to extend more credit
50,000 square foot office building
Leased to a third-party single-tenant
3 years remaining on the lease term
Unknown if tenant will renew the lease at this property
Tenant is currently paying $10 psf NNN
Market rental rate is $7 psf NNN
Market Occupancy rate is 85%
Market cap rate is 7.0%
If the tenant were to vacate space, it is expected to cost $10 psf for TI/LCs
Loan Request
The customer is seeking 75% LTV financing and the longest loan term available
The borrower will not accept a loan term less than 5 years

13

WFC - SCR 2473 Supervisory Loan to Value (SLTV) Reporting

SLTV Limit
(Loans above these limits
are SLTV exceptions)

Loan Category
Raw Land (unimproved real property)

65%

Land Development (improvement of real property prior to adding structures. May

include the laying of sewers, water pipes, utility cables, streets, and other infrastructure
necessary for future development. Synonymous with Finished Lots and Buildable Lots.)

75%

Construction (building or rehabilitating structures)

Commercial, Multifamily (including condominiums and cooperatives), and other
Nonresidential

80%

1-to-4 Family Residential

85%
Improved Property

Commercial, Multi-family, 2nd Home, Rental Homes

85%

Owner Occupied (Primary Residence)

1-to-4 family (including condominiums, cooperatives, PUDs) and home equity

90%

Intangible Personal Property (Enterprise Value {aka on-going concern}) is not considered Other Acceptable Collateral and is
not to be used in calculation of LTV.

14

General Rules of Thumb

General Rules of Thumb

Underwritten CF should accurately reflect how you think the property will perform
based on
Historical property data
Market data
Preferably a combination of both

CF should be sustainable throughout loan term and beyond

If potential disruptions to CF are anticipated, appropriate mitigate(s)/secondary
repayment source should be in place

You must be able to demonstrate and support any assumptions you make about the
historical and/or proforma CF of the property

The lower the debt service coverage on the loan, the less room for error in performance
of the project/CF analysis

15

Property Types Key Differences

Industrial

Multi-Family
Lack of leases

Environmental considerations

Advertising a big expense

Clear height

Expenses per unit per annum which units have been

remodeled (per bed for student housing)

Modified gross lease is the most common but could see

triple net

Need to be careful about annualizing

Balance of power between suppliers and tenants

Replacement reserves are above the line

Function of supply and demand

Other income could be high (parking, pets, storage,

laundry)

Basier Stop any expenses above the stop is the tenants

responsibility

Office

Retail

Plenty of supply leaser power

Leases between 3 to 5 years

Gross Lease structure

Changing consumer buying patterns

Retenanting costs many businesses are shrinking

space per person and providing work at home or visiting
cube options

Geographical

Cost to attract tenants paint/carpet

Co-tenancy provisions

Open space/flexibility

Additional rent as percentage of sales

Suburban vs central business district has higher vacancy

rates

Be careful of suburbs no barriers to entry

Generational