Risk based loan-to-value model for credit management of income producing real estate
Credit Management usually defines the maximum loan-to-value ratio solely based on the use of the property. This current practice lacks accuracy and bears to many risks while entirely disregarding the location and the quality of the specific real estate with all its potential and risks.
The introduced risk based model strives to determine risks for real estate objects within a meaningful framework of complexity ensuring an accurate calculation of loan-to-value ratio for each individual real estate object.
The model is based on the DCF-method, designed for appraisal of real estate prop- erty, and a real estate risk module for a proper risk evaluation. The real estate risk module focuses on two functions: the real estate risk rating and the calculation of an individual loan-to-value ratio, based on the real estate risk rating. The different key risks will be defined as a variance of the base loan-to-value ratio, based on the us- age of the property. A lender may influence the results of the risk parameters by emphasising certain risk parameters and by changing the security margin for the loan (risk appetite). Depending on the configuration of the basic setting and the ap- praisal of the real estate property, this risk approach will differ more or less from a conventional approach. The property itself with the qualities of its location and its fur- ther specific qualities is determining for the position within the security margin as well as for any positive and negative variations compared to conventional models. Within an average loan-to-value ratio the risk based loan model will show equal spreads as conventional results.
While appraising an existing real estate portfolio, a simplified risk assessment is possible since the pooled portfolio effect has a balancing effect. Within an existing real estate portfolio the spread of results is significant and the structure het- erogeneous. For these reasons it is recommended to use a full set of criteria to de- termine risks on the level of a single real estate object.