Faulty Pricing?

CRE Finance World, Summer 2012

Faulty Pricing? Sam Plimpton Rich Krumholz Casey Nelson Partner Analyst Analyst The Baupost Group, L.L.C. The Baupost Group, L.L.C. The Baupost Group, L.L.C. P trusts in the first quarter of 2012 generally were priced billion of distressed loans and REO from CMBS trusts, accordingThe loss in values and downturn in CRE fundamentals produceda large amount of distressed debt in CMBS, which led to a sharpincrease in the restructuring and liquidation of collateral loans.Since the beginning of 2009, special servicers have sold $18.5rices of subordinate and non-performing loans havetightened dramatically in the last 24 months relative toproperty appraisal values. Non-performing CRE loans(NPL) and real-estate owned (REO) sold out of CMBS at 95–100% of appraised value, versus 70% in late 2009, accord- to Morningstar. Exhibit 2 illustrates the quarterly sales volume of ing to Trepp. commercial real estate loan and REO sales from CMBS trusts over the last three years.1 However, the recent pricing looks aggressive, perhaps due to optimistic assumptions — both economic and transaction related — Exhibit 2 that would have to be achieved in order for investors to meet target NPL & REO Sales Volume from CMBS Trusts returns. Even accounting for leverage, the mechanics and timing of ($mill) collection may make these investments unattractive, unless there is an explicit expectation of asset price appreciation. One can easily demonstrate that a more appropriate price is roughly 80% of appraised value, to account for risk and to actually meet the target returns of NPL investors. Background: The 2007-8 financial markets crisis produced large volumes of distressed debt transactions in CRE. Values for com- mercial properties declined on average by 42% between the peak in late 2007 and the trough in April 2011, according to Moody’s/ Source: Morningstar Credit Ratings, LLC REAL Commercial Property Price Index (“CPPI”). Through late 2011, commercial values recovered by 14% from lows across all Exhibit 3 shows the average price paid for the loan or REO as a property types (Exhibit 1). percent of its recent appraisal and average loan loss severity from dispositions each quarter. These appraised values come from Exhibit 1 reports that special servicers must commission once a loan goes Moody’s/REAL Commercial Property Price Index (CPPI) into default. Exhibit 3 Average Gross Sale Proceeds as % of Updated Appraisal and Loan Loss Severity Based on data through the end of September 2011 Sources: Trepp and Morningstar. Data from Trepp only includes liquidations with a recent updated appraisal, greater than 2% severity, and disclosed sales price CRE Finance World Summer 2012 26


CRE Finance World, Summer 2012
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