The appraisal of an extended-stay hotel portfolio collateralizing a $570 million mortgage that was securitized last week has raised the eyebrows of investors.
The valuation gap is unusual. When real estate has just changed hands, the appraised value typically mirrors the purchase price. The issuers of securitizations, in turn, use that value to determine the leverage ratio of the mortgage on the properties. Because the high Cushman valuation increased the denominator, the stated loan-to-value ratio was lower than it would have been if the purchase price was used. Some investors view the higher valuation as an example of an ongoing slide in loan-underwriting standards.
Blackstone acquired the portfolio from Clarion Partners for $800 million in August. But the Cushman & Wakefield appraisal cited by lenders J.P. Morgan and Deutsche Bank valued the properties at almost $100 million more.
The loan was the senior portion of a $675 million floating-rate debt package that J.P. Morgan and Deutsche originated on Aug. 12 in conjunction with Blackstone’s acquisition of the 47-hotel portfolio. The two banks securitized the senior loan last week via a stand-alone deal (BLCP 2014-CLRN), with the investment-grade classes pricing in line with the dealers’ asking prices.
In addition to its $800 million purchase, Blackstone incurred $35.1 million of closing costs and funded $10.1 million of upfront reserves, bringing its total outlay at the closing to $845.2 million. Blackstone has also indicated that it plans to spend $63 million on renovations over four years.
The securitization documents cite multiple appraised values that Cushman provided on July 1 at the behest of J.P. Morgan and Deutsche. The brokerage supplied valuations based on whether the hotels were appraised individually or were sold to a single buyer willing to pay a premium to buy in bulk. Cushman said the "as-is" value was $833.7 million on a one-by-one basis and $885.1 million on a portfolio basis.
The brokerage also supplied "hypothetical" appraised values that factored in "all planned capital dollars" that Blackstone will put in reserve to upgrade the properties. Using that hypothetical standard, Cushman valued the portfolio at $844.8 million on a one-by-one basis and $896.3 million on a portfolio basis.
Of the four potential valuations, J.P. Morgan and Deutsche chose the highest. As a result, the loan-to-value ratio highlighted in the deal documents was 63.6% — or $570 million divided by $896.3 million — on the senior debt and 75.3% on the overall debt package. By contrast, had Blackstone’s actual $800 million purchase price been used, the leverage ratios would have been 71.3% and 84.4%.
While it’s possible that Clarion left a lot of money on the table by selling the 5,908-room portfolio to Blackstone at a below-market price, real estate pros say that seems highly unlikely, given that both companies are sophisticated institutional investors and that Clarion conducted a broad-based auction via a major brokerage, JLL.
Instead, investors contend, the use of the most-optimistic appraisal is another sign that commercial MBS issuers are pushing the envelope on credit quality. They view the use of hypothetical valuations as akin to "pro forma" underwriting, under which lenders make credit decisions based on projected increases in property cashflows, rather than in-place income. The use of pro-forma accounting was widespread as the CMBS market was peaking in 2007 and contributed to the subsequent crash.
"They call it a ‘hypothetical’ appraised value — that in itself should be a red flag," said one investor. "If you want to know what the true LTV is, you might want to use the actual purchase price."
J.P. Morgan, Deutsche and Cushman declined to comment on why the appraised value was so much higher than Blackstone’s purchase price. Blackstone and Clarion also had no comment. But the boilerplate fine print in the preliminary prospectus for the securitization effectively warns investors that the cited valuations may have little connection to reality. "Information regarding the appraised values of the Properties is presented in this offering circular for illustrative purposes only and is not intended to be a representation as to the past, present or future market values of any of the properties," the prospectus says.
Other recent stand-alone securitizations that financed the acquisitions of properties or portfolios cited appraised values that were equal or close to the purchase prices. Some examples:
- A Related Cos. partnership bought two office condominiums at Time Warner Center in Manhattan from Time Warner for $1.3 billion (plus $35 million of closing costs). Lead manager Deutsche cited a Cushman appraisal of $1.3 billion (COMM 2014-TWC).
- A Mark Karasick partnership bought the leasehold interest in the Mobil Building in Manhattan from Hiro Real Estate of Japan for $900 million (plus $59.5 million of other costs). Lead manager Morgan Stanley cited a Cushman appraisal of $900 million (MSC 2014-150E).
- Blackstone acquired two hotel portfolios from separate sellers — an OTO Development partnership and special servicer CWCapital — for a total of $503.6 million, plus $14.7 million of other costs. Lead manager J.P. Morgan cited a combined appraised value of $513.6 million (JPMCC 2014-BXH).
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