When we talk about improving “Transparency” in CMBS, what are we talking about? To me, it is the rent roll.
As an industry, we do a good job reporting on the notes and the bonds (the liability side). We do not do as good a job on the properties, as we are missing simple but critical tenant information (name, start date, end date and rent amount). Rent rolls and the tenant-level information they provide are an essential component of analyzing commercial real estate, and standard access to this data will deliver great benefits to CMBS industry, especially investors.
So why isn’t rent roll data already passed through the system? The reasons come down to existing processes and legitimate self-interest.
The analysis of commercial real estate starts with the rent roll. By adding up all the payments received from the tenants, you come up with Gross Potential Income. After deducting operating and capital expenses, the property is left with its Net Cash Flow. This number, in simplified terms, is used for valuation and risk assessment (DSCR and LTV).
– Owners start with the rent roll when they price a building to buy.
– Appraisers start with rent rolls when they value a piece of real estate.
– Brokers start with the rent roll when they put a financing / sales package together.
– Lenders start with the rent roll when they decide how much money to lend and at what term.
Why can’t CMBS investors start with the rent roll?
CMBS investors need rent roll data to accurately assess bond value, and the resulting investor confidence is essential to the longevity of the asset class. Rent roll transparency is clearly beneficial to the survival of the CMBS industry, but there are several reasons it isn’t the current standard:
1. Borrowers submit rent rolls in non-standard formats.
Borrower documents require submission of rent rolls, which is fantastic, but the rent roll data does not reach the master servicers in a standard, accessible format (it usually arrives in paper or PDFs.)
2. Not all master servicers input the details of the borrowers’ submissions.
The problem is not technology; it’s process and cost. The servicers have the technical systems to accept and pass along the rent rolls. The trick is to get the data formatted, or agree to the extra expense of entering non-formatted data.
3. Rent rolls are not required in the IRP.
If the Investor Reporting Package required the disclosure of rent roll data, the servicers would be forced to figure out how to make it happen. There’s no inspiration like necessity.
4. Privacy issues.
With transparency comes less privacy regarding the performance of a loan and its underlying real estate. We, as an industry, need to balance the transparency requirements of the investors with the confidentiality desires of the owners. It’s an issue, but one we can solve.
5. Some of us will have to change the way we do business.
On a pragmatic level, there are groups who would like to suppress (or at least not promote) data disclosures. They have been operating in a broken system, and the longer it remains broken the longer they can keep making money the same way they always have. I’m not saying these players are in any way corrupt. It’s just that they have learned to function in a dysfunctional system — and I suggest it’s time to fix that system.
What can we do?
How do you compel these competing interests to act for the good of the entire industry?
The answer rests with the CMSA’s IRP, as it is the common standard referenced in the Pooling and Servicing Agreements. PSAs are the contracts that spell out the rules and standards of the securitization. In simple terms, if the IRP requires it, everyone has to do it because the IRP is the PSA’s reporting standard. Therefore, we urge the CMSA and the MBA to act decisively and include rent roll disclosure in the XML schema of IRP 6.
Including rent roll data in IRP 6 will involve some cost, but the cost of not requiring rent rolls will be too great for the industry to survive. If rent roll disclosure is pushed back and we are forced to wait until IRP 7 (at least another two years), we will have missed a golden opportunity to make real, essential change to this market.
This industry can survive to 2009, but very few of us will still be alive in 2011.
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.