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Four Major Property Sectors Showing Weaker CMBS Loan Underwriting

Wells Fargo Sees Growing Gap Between Actual and Underwritten NOIs
February 22, 2016
Among the four major property types, loan underwriting in 2016 appears weaker relative to 2015, according to new research from Wells Fargo Securities based on its analysis of nine conduit CMBS transactions with a balance of $8.3 billion that have come to market so far this year.

In office-backed CMBS loans so far this year, the average debt service coverage ratio (DSCR) of 1.67x in 2016, us down from 1.84x the prior year. DSCR measures projected annual net operating income (NOI) in relation to the annual amount of loan repayment.

With the exception of retail, all sectors are reporting lower debt yields on average. The average debt yield for multifamily-backed loans has declined to 8.3% in 2016, compared to 8.7% in 2015 and 9% in 2014.

All of the four major property types are also seeing more interest-only (IO) loans. While hotel-backed loans continue to show the lowest percentage of IO among the major property types, exposure is up to 47.8% in 2016, from 39.1% the prior year, according to Wells Fargo Securities.

Underwritten vs. In-Place NOI Divergence

While assumed NOI growth at underwriting is in many cases supported by new leasing activity, Wells Fargo noted that it sees a growing gap between prior in-place financials and underwriting assumptions, which it considers an indicator of increasing risk.

For loans in post-2007 financial crisis transactions, Wells Fargo also noted a growing disparity between underwritten net operating income (NOI) and the most recent NOI reported prior to securitization.

On average, loans securitized in 2015 showed the underwritten NOI as 8.8% higher than the NOI reported prior to securitization. That is up from a difference of 8% in 2014 and 5.8% in 2013.

Among the property types, only multifamily and hotel-backed loans showed improvement in 2015. Encouragingly, underwritten NOIs for hotel-backed loans remain conservative, averaging 3.2% lower than the NOI prior to securitization in 2015.

Office, industrial and retail-backed loans continue to be the main drivers behind the gap in underwritten versus actual NOI, with average differences in 2015 of 17.1%, 10.1%, and 9.6%, respectively, the Wells Fargo report noted.

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