Real Estate Values, do you have a loan to value exception?

This is a common question.  Most banks in the past have financed 75-80% of the value of the property.  Some have financed more, few have financed less historically.  Many business owners are experiencing mortgage maturities and are seeing dramatic declines in value.  When the loan to value exceeds between 80-85%, your bank may notify you that there is a loan to value exception.  Loan to value guidelines are set for banks under the Financial Institutions Real Estate Act (FIREA)


Banks are required by law to order an updated appraisal whenever the mortgage has a maturity.  The appraisal has three approaches to value.  The cost approach-how much does it cost to build the structure in the current market.  The sales comparison approach-what are the current comparable properties selling for in this market.  The income approach-taking the net operating income of the project and applying a capitalization rate.


Many banks feel that two of these approaches are not currently relevant.  Since there is little to no new construction going right now, the cost approach is not applicable in most circumstances.  Many of the current comparable sales are either short sales or bank foreclosures, it could be argued that the sales comparison approach does not give relevant data either.


Most banks are using the income approach to value.  This approach takes the current lease income (with a slight reduction for potential or current vacancy), subtract operating expenses taxes, insurance and other expenses and come up with a net operating income (NOI).  With that number you apply a capitalization rate (the return most investors are looking for in the current market).  Cap rates are subjective, but it seems that banks are applying cap rates between 9 and 10%.  Some higher and some lower.


Because of the current circumstances going on in the market, most banks feel the income approach to value is most relevant.  Specifically, a commercial property is valued based on the income it generates.   What do you think?