Real estate related loan auctions for 2009 show that non-performing CRE debt traded at a premium to non-performing residential real estate debt. Non-performing CRE debt sold for 37% of book value on average, while non-performing residential debt sold for 23% of book.

• The thing that is striking though is that when both loan types are performing, there is no discount given for the residential debt. 
• Performing loans of both types sold for 57% of book value. 

The graph below shows the performing/non-performing gap in loan prices.  The gap between performing and non-performing for residential loans is 35% of book value, while for CRE is just 20% of book value.

• The important difference might not be between the two types of loans at the non-performing level.  The important difference might be at the performing level.  Buyers of residential loans might be assuming that if the loan isn’t in default by 2009, it might hold up.  Whereas Buyers of CRE loans have to figure in a greater risk of future default (because the commercial market is lagging residential).
• The cost of foreclosure as a percent of book value is higher among residential loans, which means that you have to apply a formula like ((Loans In Default * Market Pullback) + (Loans in Default * Cost of Foreclosure)) * Average Hold Time * Required Return in order to arrive at the property discount.  The cost of foreclosure is likely to be similar for a house and a commercial property, though the loan amounts are quite different (the average residential loan sold had a book value of $167,000 and the average CRE loan had a book value of $466,000).

Tags: Non Performing CRE Debt

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