The price at which a discounted payoff matches enforcement moves more with the timetable than with the valuation, and the timetable is the part nobody owns.
A lender holds a matured loan of 82.5 on a building worth 77.4. The borrower offers to
pay it out at 72 cents on the euro, in six months. The committee will spend an hour arguing
about whether that is enough. The arithmetic takes four lines, and it says the offer is worth
10.48 million more in present value than enforcing.
The number the argument turns on is the price at which a discounted payoff exactly
matches what enforcement would return. On this loan it is 58.7 cents. Above it,
take the payoff; below it, enforce. It is one formula, and it contains nothing about the
borrower, the covenants, the margin or the maturity date.
What the lender is choosing between
Present value
Recovery on the loan
Enforce and sell, 2.25 years out
46.42
56.3%
Accept the payoff at 72 cents, paid in six months
56.89
69.0%
The price at which the two are identical
58.7 cents
—
A building at 5.15 of net operating income on a 6.65% yield, worth 77.4, against a loan of 82.5. Everything below is that arithmetic and nothing else.
What a month of delay costs
Enforcement is priced over a timetable, and the timetable is the part of the estimate
nobody owns. A receiver appointed in March sells in the autumn, or the following spring, or
the one after that, depending on a tenant dispute nobody has read yet.
Each month the sale slips costs the lender 0.56 cents on the euro, which
on this loan is €463k of present value. Not a rounding error: it is the
same order as the legal budget for the whole enforcement, spent every month, invisibly.
Enforcement slips by
Indifference point
Cents given away
In euros
one month
58.2 cents
0.56
0.46
3 months
57.1 cents
1.67
1.38
6 months
55.5 cents
3.29
2.71
12 months
52.3 cents
6.41
5.28
18 months
49.4 cents
9.36
7.72
24 months
46.6 cents
12.15
10.03
Every other assumption held. The euro column is present value on the 82.5 loan.
A year of slippage costs 6.41 cents, or €5.28 million. That is the
arithmetic behind a rule most workout teams already follow by instinct and rarely price: a
process that can be finished is worth more than a process that can be won.
The lever that moves it most is not the one you would name
Ask a workout team which input destroys the most value in an enforcement and you will
hear the forced-sale discount, then the delay. Over the range those two actually vary, that
is right. Per percentage point, it is not.
Input
Cents per percentage point
Carrying cost, per year
1.82
Discount rate
0.93
Forced-sale discount
0.76
Transaction costs
0.66
One percentage point added to each input in turn, from the base case.
The carrying cost — voids, rates, insurance, security, the running loss on a
building nobody is managing for value — moves the number 2.4 times as
much per point as the forced-sale discount. It is also the only line of the four that a lender
can act on directly while the process runs, and the one that gets the least attention because
it arrives as a series of small invoices rather than as a single number in a valuation report.
Input
From
To
Cents lost
Forced-sale discount
18%
30%
9.15
Time to completion
2.25 years
4 years
10.77
Discount rate
9%
12%
2.73
Carrying cost
2.1%
3.5%
2.54
Transaction costs
5.5%
8%
1.65
The same four inputs over the range a committee would actually argue about.
Both readings are true and they answer different questions. The plausible range is what
the committee should argue about. The per-point figure is what the asset manager should act on,
because it is the only one of the four they control week to week.
One line of the table is worth reading twice. Raising the forced-sale discount from
18% to 30% costs 9.15 cents — not the ten one might round it to. The
threshold where the loss does pass ten cents is a discount of 31.1%. Stretching the timetable to
four years, by contrast, costs 10.77 cents. Time is the bigger of the two, and it is the one no
valuer will put in writing.
How wrong would you have to be?
Sensitivity tables tell a committee how the answer moves. They do not tell it whether the
answer is safe. The question a credit committee is actually asking is the inverse one: how
wrong would we have to be about enforcement before accepting 72 cents turns out to have been a
mistake?
For a 72-cent payoff to be the wrong answer…
…this input would have to be
Against a base case of
The forced-sale discount
0.6%
18%
The time to completion
5.6 months
27 months
The building's value
94.9
77.4
Any one of costs, carry or discount rate, at its limit
64.9 cents — short
—
The best pair of the three, both at their limits
69.1 cents — still short
—
All three at once, each at its limit
73.1 cents — past the offer
—
Each line moves one input alone until the indifference point reaches the offer.
None of the first three is a plausible error. A forced-sale discount of 0.6% means a
distressed sale that is not distressed. Completing an enforcement in 5.6 months means no
contested possession, no marketing period and no completion risk. A building worth 94.9 is the
valuation the lender wishes it had, not the one it has.
The last three lines are the interesting ones, and the first draft of this article got
them wrong. Set the transaction costs to zero and the number reaches 62.4 cents. Set the carrying
cost to zero as well — the best pair of the three, both at their absolute limits —
and it reaches 69.1. Still short. Add the third, a 3% discount rate on a distressed asset, and
it finally passes the offer, at 73.1 cents.
So the honest statement is narrower than “the payoff wins whatever you assume”,
and more useful. No single error and no pair of errors reverses the decision.
It takes all three secondary inputs at once, each at a value no workout file would survive
being asked to defend: no legal or agency cost at all, no void, no insurance, no security, and
a discount rate on a defaulted loan below what the lender pays for its own funding.
Put plausible favourable numbers in instead — costs at 3%, carry at 1%, a 7%
discount rate — and the indifference point is 64.5 cents. Grant an eighteen-month
enforcement on top of that, against the 27 months assumed, and it is 68.5. The offer is still the
better trade.
What to put in front of the committee
Three lines, and none of them requires agreeing on the valuation.
One. The indifference point, computed: 58.7 cents. The offer is 72. The
gap is 13.3 cents, or €10.48 million of present value.
Two. The cost of the timetable: €463k a month, 6.41 cents a year. That
is the number that decides whether to fight over a possession order.
Three. What it would take to be wrong: a forced-sale discount of 0.6%, or
an enforcement completed in 5.6 months. Say those out loud and the discussion is over.
The point of pricing four exits on one horizon is not to produce a recommendation. It is
to produce a recommendation that survives being wrong.
The workbook behind this article
Every figure above is a live formula in the companion file for
The Real Estate Workout, which also holds the extension with its unpaid interest capitalised, the same loan run through six asset classes, the option value of waiting a year, and the eighty diligence questions that mark any answer without a source document as unanswered. It is free, and it needs no account and
no email address.
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Does an undrawn revolver count as liquidity?67.4567 per cent of the headroom, and it leaves at a fall in annual revenue of 8.4127 per cent — not the 13.3333 per cent the board deck implies.
Does supply chain finance count as debt?66,049,315 released, and leverage of 2.7622× or 3.1362× depending on which balance the test is asked of — the second is a breach at today's EBITDA.
How do you set a minimum cash balance?Three components, 124,596,281 in total — and the double count that turns a margin of 27,403,719 into an apparent shortfall of -3,988,281.
Is a 2/10 net 60 discount worth taking?An annualised 14.8980 per cent against a revolver at 4.50 per cent — worth 5,471,890 a year, and 0.3132 turns of reported leverage.
At what wealth does a family office pay?A five-person office costs the same $2,442,000 at $100m as at $2bn. Against a tiered multi-family schedule the two curves cross exactly once.
Does the fulcrum move with enterprise value?A worked capital structure at three enterprise values. The break migrates from the first lien to the subordinated notes without a single document changing.
How many companies does a reserve pool defend?Holding pro rata to the Series D costs $14.76m per company. A $40m reserve defends 2.71 of forty — and 61 per cent of the cost is the last round.
How much room a 1.15x downside actually leaves79 basis points of margin. The leverage covenant fails first, five basis points before the coverage covenant the chapter reports on, and 4.6 per cent of EBITDA is the whole cushion.
How the GP catch-up is actually solvedMost write-ups state the catch-up formula then hardcode the answer. Set it as a solve and it moves on its own when the carry rate does.
Six ways to state the same fund's return7.12 per cent, 18.04 per cent, or 1.323 times the public market — one fund, one set of flows. The eleven-point gap is the valuation, and it is not cash.
The IRR at which a closed-ended fund merely tiesA drawdown fund advertising 13.25 per cent ties an evergreen netting 8.64. On committed rather than called capital, 78.7 per cent of the edge vanishes.
The month a remediation trigger has to be armed byMonth 8, on a one-year window and a 14-week hiring lead time. The date is 12W − L/4.33 and holds for any portfolio size — the book only changes the euros.
Two routes to the same NAVFive findings in one quarter-end close, and not one of them was a modelling error. Every one was a control that did not exist.
What a CBAM certificate buffer costs to holdCarry and protection are both linear in the buffer, so the break-even probability is identical at 5 per cent and at 30 — and 2027 costs exactly twice 2026.
What a clawback actually collateralises24 million recovers 13.20 net of tax and 7.20 is escrowed. The rule is e ≥ 1 − t, and every euro won on the tax clause lands uncollateralised.
What a co-investment programme actually saves37 basis points, and a 22.8 per cent total-loss rate erases it. At the usual per-deal cap a single failure is 37 per cent of the annual cohort.
What a diligence exercise actually recoversEighteen basis points is only the part that reaches the yield. Three of the four instruments never do, and the exercise is worth thirty-one.
What a follow-on reserve is actually worth0.019 turns under plain dilution, 0.285 under pay-to-play. The optimum is a property of the shareholders’ agreement, not of the portfolio.
What a lease mark-to-market is actually worth5,788,000 becomes 807,365 once the over-market stream, the expiry dates and the cost of re-letting are priced — and nothing at all below a 43.7 per cent renewal rate.
What a minimum payment actually does£81.53 leaves the account and £20.46 reaches the debt. On minimums alone the set clears in 258 months and repays 1.78 times what was borrowed.
What a pro rata cheque actually costsDefending costs 1.25 times the initial cheque across two rounds, not more in each — and below a 521 exit the follow-on dollars come back worth less than they cost.
What a subscription line does to the IRR20 per cent becomes 38.41 on the same asset while the multiple falls. Two dollars of interest buys 18.4 points, and the longer the line runs the cheaper each point gets.
What one point of fees actually costsOne point on the annual charge turns 738,846 into 567,961 over forty years — 23 per cent of the pot, and 2.43 of wealth lost per 1 of fee.
When the promote stops clearingCarried interest is not proportional to performance near the hurdle. It is a step function, and $2m of headroom is what stands between a promote and none.
Why a secondaries bid-ask gap has no zoneThe seller’s floor and the buyer’s ceiling are one formula at two rates. At equal required returns the zone is exactly zero — here it is 11.02 points apart.
Why refining a due diligence rubric makes it weakerThree of twelve managers carry a terminal flaw and the average approves all three. Splitting eight domains into sixteen makes it easier to hide, not harder.