Underwriting – as it is applied to commercial income-producing property capital financing transactions – is the process of reviewing, investigating and analyzing the income-generating ability of a given commercial income-producing property in terms of its debt support characteristics, its collateral value, the supporting credit issues that pertain to liquidity support for the future operations, and the issues that may result in a default. This underwriting process is undertaken by the INVIZEN RTU program model in light of current capital market conditions and expectations, as well as the realities of the impacts that are likely to occur as a result of forecasted near-term market conditions. Capacity underwriting is the most important part of the underwriting process as the chief means of creating wealth and value for commercial properties is derived from the income-generating capacity of the property once the raw land has been converted into a commercial use via improvements. Accordingly, in a market economy such as that of the United States, capacity underwriting is the most important component to the overall underwriting regimen, with the results of said capacity analysis acting as important drivers for the three (3) remaining underwriting analyses that are routinely conducted to determine the overall risks and rewards potential a given property or business may present to the capital markets.
The key issue that cannot be eliminated pertains to market disruptions. By their very nature, market disruptions are not foreseeable and are therefore outside of the scope of consideration, as this portion of market risk is not manageable by any means in 100% of cases. That aside, the market feasibility analysis process pertaining to a specific class of business operations within a given geographical marketing area, provides a strong basis for better decision-making where the latest data is available at any point in the decision-making process. The INVIZEN approach is predicated upon the idea that continual updates of data sets throughout the project life cycle will, over time, allow capital market participants to make better decisions regarding the deployment of capital funds by focusing on a forecast window of only 24 months, as this period is the longest period of a forecast that is likely to have a predictable outcome and provide the opportunity for an orderly sale of the business in cases where the market opportunity is expected to continue to deteriorate.
The RTU reporting series collateral underwriting component analysis uses a set of defined means and methods that are intentionally designed to support the INVIZEN Real-Time Status (“RTS”) Investment Protection Program requirements. These requirements serve as the conditions precedent to helping prevent materially-significant loan loss severity risk (or investment loss severity risk in the case of equity investors and investments, as the case may be) from accruing for the full term of the entire capital investment (loan and equity capital). The entire purpose of the INVIZEN Real-Time Analytics (RTA) program is to support the end-result of investment protection maximization for the benefit of all the financial stakeholders in a given business enterprise.
The second key component of this process is the collateral underwriting review. The purpose of collateral underwriting is to ensure the assets to be purchased by the prospective financial participants are in fact well worth the money paid for them. This requires the underwriter to undertake a collateral underwriting review. The collateral underwriting review consists of verifying the ownership of any proposed collateral, the value of assets that require construction or assembly, the value of real property and the value of the ongoing operations of the business model to be utilized by the operating company on behalf of the sponsor (and subscribers to the anticipated offering). Under the INVIZEN underwriting approach, collateral risk underwriting relies heavily upon the findings of the capacity risk underwriting process because the value of any parcel of property is directly related to the future economic yield it can generate, in and of itself, and not that value (per se) that would correspond to comparable market properties or the replacement value of collateral that has been compromised by an insured event. The ownership and use of the proposed collateral is governed by legal documents for which a legal opinion is required and should be presented prior to the closing of any financial transaction, lest these matters become the subject of contention between the parties in the future.
In business, collateral assets are only worth the present value of the future income the assets can be reasonably-expected to generate over some future period of time, as the purpose of business investing is to secure a future financial gain. INVIZEN focuses its attention on this key issue by demonstrating the potential value of the sum-total of the subject business’ assets and operations in terms of a range of capitalized values. In turn, these capitalized values are demonstrated in terms of a spread of capitalization rates that represent a deviation of up to +/-15% of the current market capitalization rates that are being used (net of all fees and transaction costs) in the market today for essentially similar classes of business assets, prior to a red flag being set for this line item. The INVIZEN model’s survey of the market found the current average capitalization rate for assets essentially similar to the subject property and business to be 5.54%. Accordingly, this rate was used for a baseline computation of the potential value of the assets of the subject business and property, with the -13.59% deviation from the sponsor assumed capitalization rate being computed. The results outside the margins of the market by a significant factor.
The future collateral value will be largely dependent upon the utilization value of the assets over the holding period. The utilization value is impacted by: (i) changes in consumer/end-user purchasing preferences – essentially, market risk exposure; and (ii) the relative condition (or impairment) of the assets over that period of time – essentially, the potential decline of the assets due to age, wear and tear. The INVIZEN model focuses on the following key issues to resolve these matters:
- Market Risk Exposure. Market risk exposure – as it pertains to the collateral underwriting issues at hand – chiefly consists of the following factors: (i) the potential for a market disruption that could lead to changes in consumer/end-user purchasing preferences to a point where functional obsolescence of the assets of the subject business, thus impairing the value of the assets; and (ii) the over-saturation of the geographical primary marketing area by competing businesses and properties to the point wherein the value of the assets may be impaired due to a reliance upon price reductions as the chief means of capturing market share. This history of capitalism over the past century has ample demonstrations of market disruptions in various industries that were difficult and/or impossible to foresee with sufficient advance notice for the subject industries to make significant competitive changes in the majority of cases. The only reliable method of safeguarding a business against market disruptions is to continually survey the market to determine the potential changes of consumer/end-user purchasing preferences far enough in advance to provide a measure of insultation against a disruption that may have the potential to dramatically reduce the value of the subject business and property operations collateral (i.e.: the INVIZEN Real-Time Status Reporting System). Market saturation – in almost every case – is an issue that develops over time and has the same resolution to that of market disruptions. Accordingly, the chief due diligence issue pertaining to market risk exposure is to determine if the sponsor has a demonstrable plan of action and management reporting regarding the periodic surveying of current market conditions and consumer/end-user purchasing preferences.
- Asset Condition. Asset condition is a critical issue for commercial income-producing properties. The old adage of, “work she may, shine she must”, definitely applies to many types of commercial income-producing properties and businesses. Human assets constantly change over time, but the establishment of training norms and reporting regimens can largely reduce or eliminate the impact of changing human capital to the overall asset valuation analysis. The practical impact of this issue on underwriting is the requirement of the financial participants in a given transaction to review management’s plans for employee management and service delivery to determine if they are reasonably complete enough to warrant further investor interest. The more important issue is “asset impairment” – a term that essentially pertains to the fact the structures, equipment, fixtures and furnishings will deteriorate over time from use and must be repaired or replaced in order for the subject property to remain competitive with newer properties and businesses. The INVIZEN model addresses this issue by:
- Determining the relative age of the subject property and business to that of its market peer group; and
- Determining the relative amount of accumulated depreciation, the subject property and business is likely to have accrued, all things being equal, that could bear on the transaction; and
- Determining the relative amount of capital deployed for the purposes of maintaining the subject property and business assets moving forward; and
- Creating an analysis and calculation of the relative amounts of capital that may be deployed in excess of the sponsor’s calculations (or in lieu of the sponsor’s calculations, as the case may be).