Same building, same timetable, two discount rates: the buyer's bid, the seller's hold value, and the gap that decides whether a loan sale clears.
A buyer prices a non-performing commercial real estate loan as the present value, at its target return, of what enforcing the loan will collect, less its own deal costs. On an illustrative €82.5 million defaulted office loan whose enforcement nets €56.35 million in 2.25 years, a 15 per cent buyer bids €40.32 million, 48.9 cents on the euro. The selling lender's own hold value at 9 per cent is 56.3 cents, so the 7.4-cent gap, not the price, is the real subject of the negotiation.
Worked in full in The Real Estate Workout by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A lender and a loan buyer looking at the same defaulted loan usually agree on the building's value and on the enforcement timetable, give or take. They differ on the rate. The lender discounts the recovery at its own cost of carrying a distressed asset; the buyer, typically an opportunistic fund, discounts at the unlevered return its investors expect, plus a cushion for what it has not been able to diligence. Same cash flows, two rates, two prices. Whether a sale clears depends on what each side does about that gap.
| Input | Value |
|---|---|
| Loan outstanding, accrued interest included | 82.50 |
| Net operating income today | 5.15 |
| Market yield today | 6.65% |
| Forced-sale discount in enforcement | 18% |
| Enforcement costs, share of gross proceeds | 5.5% |
| Holding costs a year, share of value | 2.1% |
| Years to cash | 2.25 |
| Seller's discount rate for a distressed asset | 9% |
| Buyer's target unlevered IRR (illustrative) | 15% |
| Buyer's diligence and transaction costs, share of the loan | 1.0% |
1. Value the collateral: 5.15 ÷ 6.65% = 77.44.
2. Net enforcement proceeds: 77.44 × (1 − 18%) = 63.50 gross; less 5.5% costs; less 2.1% × 77.44 × 2.25 years of holding cost = 56.35, or 68.3 cents.
3. Discount at the buyer's IRR: 56.35 ÷ 1.152.25 = 41.15.
4. Deduct the buyer's costs: 41.15 − 0.825 = 40.32, which is 48.9 cents on 82.50.
Seller's hold value: 56.35 ÷ 1.092.25 = 46.42, 56.3 cents.
In Excel: =NetProceeds/(1+IRR)^Years-Loan*CostPct, and to test a price, the buyer's IRR is =(NetProceeds/(Price+Costs))^(1/Years)-1.
At 48.9 cents the buyer earns 15 per cent and a money multiple of 1.37. The seller would be giving up €6.10 million against holding the loan and enforcing it itself. At the seller's hold value of 46.42 the buyer's return falls to 8.1 per cent, which no opportunistic fund will accept for a 2.25-year enforcement. On these inputs there is no price at which both sides are better off, and most loan sale processes that fail do so here, after months of diligence, because nobody computed this gap before launching.
Three things close it. The buyer can be faster: a specialist that completes in 1.5 years instead of 2.25 saves holding cost and time, nets 57.57, and can bid 55.6 cents at the same 15 per cent, almost the seller's 56.3. The seller's true cost of holding can be higher than 9 per cent: once capital held against a defaulted exposure, staff time and the volatility of the provision are counted, a seller whose real rate is 16.0 per cent is indifferent at the buyer's bid. Or the buyer has a route the seller does not, typically a negotiated exit with the borrower, which is a different set of cash flows altogether.
| Buyer's target IRR | 1.5 years | 2.25 years | 3.0 years |
|---|---|---|---|
| 12% | 57.9 | 51.9 | 46.6 |
| 15% | 55.6 | 48.9 | 42.9 |
| 18% | 53.4 | 46.1 | 39.7 |
| 20% | 52.1 | 44.3 | 37.7 |
Each extra year on the timetable costs the buyer about 8.4 cents of bid at 15 per cent; five points of IRR, from 15 to 20 per cent, cost 4.6. Timetable risk therefore deserves as much diligence as the building: a jurisdiction where enforcement takes three years instead of two moves the price more than the gap between a core-plus and an opportunistic buyer. The same effect on a residential note, where the courts set the timetable, is in what a judicial foreclosure takes off the bid. The seller's hold value moves with the timetable too, but by less, because its rate is lower.
Compare every bid with the borrower's alternative. On the same loan the payoff at which a discounted payoff matches enforcement is 58.7 cents, and the payoff on the table in the book's case is 56.89, or 69.0 cents. A lender that sells at 48.9 cents to a fund that then settles with the borrower at 69.0 has transferred the difference, not realised a loss it could not avoid.
Pricing the loan from its collateral value or its recovery rate. The building is worth 77.44, which is 93.9 cents on the loan, and enforcement nets 68.3 cents, so a seller who hears 48.9 feels robbed. Neither of those numbers is a price: the first ignores the forced-sale discount and costs, the second ignores time. The bid is the second number discounted at the buyer's rate. Put both sides' discounting on one page before launching a sale, and the conversation becomes about rates and timetables, which can be negotiated, rather than about a building neither side controls. The same discipline applied to the borrower's offer is in how to calculate a discounted payoff price.
NPL bid = net enforcement proceeds ÷ (1 + buyer's IRR)years − buyer's costs: 48.9 cents here at 15 per cent, against a seller's hold value of 56.3 cents at 9 per cent. A specialist that enforces in 1.5 years bids 55.6. The enforcement bridge, the sensitivity grid over the discount and the delay, and the four options on one horizon are in the free workbook for this case.
Opportunistic buyers typically underwrite mid-teens unlevered returns or more, illustratively 15 per cent here. On a loan netting 56.35 million in 2.25 years that means a bid of 48.9 cents on an 82.5 million loan; at 20 per cent it falls to 44.3 cents, and at 12 per cent it rises to 51.9 cents.
Because their own hold value, discounting the same recovery at a lower rate, is higher. At 9 per cent the seller's value is 56.3 cents against a 48.9 cent bid at 15 per cent, a gap of 6.10 million on an 82.5 million loan. A sale clears only if the buyer is faster or cheaper, or the seller's true holding cost is nearer 16.0 per cent.
A lot. At a 15 per cent target return the bid on this loan is 55.6 cents if enforcement completes in 1.5 years, 48.9 cents at 2.25 years and 42.9 cents at 3.0 years: about 8.4 cents of price per year, against 4.6 cents for five more points of target IRR.
This article is one calculation from The Real Estate Workout. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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