Commercial Real Estate Stress Testing
By: Stephen Rountree
Commercial Real Estate (CRE) underwriting and repayment analysis should incorporate various stress testing scenarios. In the current rising interest rate environment, prudent underwriting should evaluate the effect rising interest rates will have on borrower repayment ability. Stressing appraisal cap rates is also recommended to evaluate the effect rising rates will have on collateral values. SHPCO is available to assist in loan underwriting and stress testing.
Within our client bank’s underwriting, we are seeing various interest rate stressing assumptions – from 100 to 300 basis point shocks. Cap rates are also being shocked from 100 to 250 basis points.
The following is a sample stressed underwriting analysis for a $3.5 million dollar CRE loan. This analysis includes a graduated $80,000 reduction in project net operating income. The loan interest rate is stressed 200 basis points on both a thirty and twenty year repayment structure. As seen below, debt coverage under the assumptions range from 1.56x to a stressed 0.83x.
Within our client bank’s underwriting, we are seeing various interest rate stressing assumptions – from 100 to 300 basis point shocks. Cap rates are also being shocked from 100 to 250 basis points.
The following is a sample stressed underwriting analysis for a $3.5 million dollar CRE loan. This analysis includes a graduated $80,000 reduction in project net operating income. The loan interest rate is stressed 200 basis points on both a thirty and twenty year repayment structure. As seen below, debt coverage under the assumptions range from 1.56x to a stressed 0.83x.
The following analysis was performed on a $9.9 million hotel loan. Stabilized income was stressed assuming a 15%, 25%, and 35% reduction in revenue per available room (REVPAR). Debt service coverage was stressed based on an assumed 200 basis point interest rate shock with repayment terms of thirty and twenty years. Property valuation was stressed based on a 250 basis point increase to the appraisal cap rate. As seen below, debt service coverage ranged from 1.93x to a stressed 0.73x. The stress of the capitalization rate resulted in a range of values for the project from $20.4 million to $11.2 million utilizing a 6% cap rate and from $14.4 million to $7.9 million utilizing an 8.5% cap rate.