Commercial lenders are responding to higher interest rates and market uncertainty by slowing their commercial real estate (CRE) activity. The caution extends to existing loans, with lenders scrutinizing the borrower’s ability to refinance at higher rates. So far, the Mortgage Bankers Association has revised its forecast for commercial property originations from an initial projection of a 12% increase in 2022 to an 18% decline.

Overall, banks are tightening their underwriting standards across CRE loan categories and seeking a better risk/return balance. Lenders are subject to federal underwriting, risk management and appraisal regulations, with regulators requiring banks to create processes to support independent real estate appraisal and evaluation programs. Within the guidelines, loan-to-value (LTV) maximums by CRE property type are designed to make lenders less vulnerable to CRE market trends.

The current climate makes understanding the lender’s mindset and the periodic evaluation processes built into existing CRE loans critical for property owners and chief financial officers (CFOs). Here are three things you can do to manage current CRE loans and optimize the value of your property portfolio.

Three Things You Can Do to Manage CRE Loans and Optimize The Value of Your Property Portfolio

The loan-to-value formula for CRE is straightforward. Lenders calculate LTV by dividing the loan amount by the lesser of the property’s appraised value or purchase price. In general, lower LTVs qualify for better financing rates.

For commercial properties, acceptable LTVs are typically in the 65 to 80% range. As lenders tighten the criteria, LTVs are in the lower to middle part of the range, with 80% LTVs less common compared to a few years ago. However, the property type is also a factor. For example, a bank may approve an 80% LTV for a multifamily property but not go higher than 65% for an urban office property in the current environment.

For existing loans, recurring appraisals or valuations come into play. Depending on the terms of your loan, your lender will review the valuation of the property on a periodic basis, usually annually or every other year. If a property’s valuation decreases significantly, it can fall below the lender’s LTV formula. Knowing where your loan sits within the bank’s formula helps you know what to expect when it’s time to refinance.

2. Monitor trends at industry, national and local levels.

Today’s CRE market is full of unknowns, which can increase the risk for property owners and lenders alike. Keeping your finger on the market’s pulse is essential to identify potential implications for your property’s valuation and financing.

At the macro level, commercial real estate is going through a transformational period with changes in how buildings are used and valued. Ongoing economic uncertainty further complicates the process of determining property values and assessing risk.

Property type and local market trends continue to play vital roles in appraisal values and financing decisions. Overall, industrial and multifamily residential property values are up since 2020 while office and retail property values are regaining ground. However, market-specific factors can create significant variances at the local level. Working with lenders and appraisers with expertise in the local CRE market can make a difference in how properties are evaluated over the course of the loan period.

3. Anticipate opportunities to increase your property’s value.

Appraisers report what’s reflected in the market based on the immediate past and trends for the future. Property owners and CFOs can optimize the value of a commercial property so that it outperforms the market comps that will be part of the appraisal process. For example, as Class A and B office space continues to adapt to the post-COVID environment, many companies are shrinking the amount of space they need and subleasing the extra space to generate income and enhance the property value. Making value-add improvements to the space to attract tenants or improve operating efficiencies may also make sense in anticipation of valuations and refinancing.

Being proactive can pay off when it’s time to refinance in the current CRE environment. The fair market value determined during an appraisal takes a snapshot of the property’s value. If the valuation drops, a loan might now fall outside of the lender’s LTV formula, requiring additional cash from the property owner when refinancing. On the flip side, some property types might see a significant increase in valuation, which may present property owners with an opportunity to refinance and get additional money out of the property.

The dedicated commercial real estate team at CBIZ can help you optimize industry trends and market opportunities. Connect with a member of our Commercial Real Estate team and gain access to more resources. 

© Copyright CBIZ, Inc. All rights reserved. Use of the material contained herein without the express written consent of the firms is prohibited by law. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ). This publication is protected by U.S. and international copyright laws and treaties. Material contained in this publication is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their organization.