Rapid Due Diligence and Valuation of Loan Potfolios

Large loan portfolio sales have moved in the direction of widely marketed public bids, where the time to review the offered portfolio is short and the cost to perform due diligence is high. Thus, valuation consultants assisting with bid pricing must be in a position to deliver a rapid portfolio review and valuation that the investor/client can rely on. Four critical issues are:

Standardized Data Capture
Investors may be faced with getting their arms around the value of as many as 200 real estate loans when preparing for a bid. If the portfolio is widely marketed, not much time will be allowed. In order for the client to submit a worthwhile bid, the underwriting and due diligence process must be precise with information regarding each loan gathered in a uniform fashion. That information gathering device, or template, should be constructed in a collaborative way between the client and the valuation firm prior to the loan file review, be reflective of the scope of work, and be based on a format that addresses the client’s investment style and conforms with their portfolio roll-up valuation model. Although basic principles always apply to data gathering templates, it will likely change with each mandate.

Strong Market Analytics
An important part of any loan file review is the aggregation of accurate and timely information regarding the property market and comparable properties proximate to the collateral. Subscription based information systems are a must, but even more important are telephone calls made to multiple local market participants. Investment brokers, appraisers, asset managers, property managers and ex, reformed real estate developers should be accessed for market color and applicable information. So much of the loan valuation entails anecdotal evidence of the market trend with regards to cap rates, rent concessions and lease structures, and how investors are choosing to look at potential investment opportunities. Conversations should be noted in the valuation template, and the information gleaned should be used responsibly in the valuation process. Good information is gained by knowing the right questions to ask, and being persistent in finding well-informed locals willing to share information with you.

Operating Statement Analysis
The nuts and bolts of the asset valuation process begins with an analytical cleansing of both sides of the historical operating statements provided by the borrower. In a best case scenario the analyst is able to review the past three years of prior operating history, and perhaps a YTD, or TTM operating statement. Whatever time frame is available, it’s almost certain that the analyst will have some work to do to make sure the operating statement accurately reflects the property’s true economic potential. On the revenue side particular care needs to be given to over-market contract base rents. Whether the over-market rate is a result of over-market TI amortization, or the vintage of lease execution, rents should be marked to market to give a true long-term perspective of the revenue generating ability of the property. For retail properties, do occupancy costs exceed a maximum percentage of store sales? Also, expense reimbursements and other income coming from properties whose occupancies exceed the market rate should be studied. If the superior occupancy rate at the subject can’t be justified these revenue streams are illusory. On the expense side, the analyst must be concerned with owner’s expenses buried inside property operations, one-time extraordinary operating expenses, and capital items that should be considered outside the operating statement. Concluding an operating statement that fairly reflects the economic potential of the property is a combination of art and science. The ultimate underwritten NOI should be debated and considered from many angles.

Logical Path of Resolution
After having spent a day or more collecting data on one loan file and trying to make sense of it, the analyst should be in a position to share with the client what he thinks will be the likely path of loan resolution. Nobody should know the loan file and property as well as the analyst assigned the loan. Three opinions need to be delivered: the time until a resolution event occurs, the type of resolution event, and the cost of such resolution. The client may have his own ideas and may even discard the opinion offered. Nevertheless, the analyst needs to formulate ideas regarding these three considerations while developing estimates of value for the collateral, and then being prepared to deliver it on the roll-up call.