A few months ago, I wondered in this space whether the market was getting ahead of itself when it came to the kinds of prices being paid for trophy assets, given that the underlying market fundamentals are still spotty. The deals we’ve reported on GlobeSt.com have since provided more examples of core properties selling at higher-than-expected metrics, and while it’s encouraging to see investors putting their money where their confidence is, at the same time we’re still getting very mixed reports about the prospects for economic recovery.

Overseas in recent weeks, you’ve had the sovereign debt crisis in Greece making headlines almost daily, while closer to home, Ben Bernanke admitted in a press conference last week that the “headwinds” buffeting the economy have been “more persistent than we thought.” The Federal Reserve chairman implying that he’s flummoxed by the refusal of the downturn to go away quietly isn’t exactly news to make everyone raise his or her glass in a toast. Bernanke’s comments might move you to knock back a few stiff drinks, but not in celebration.  

In a daily e-newsletter Tuesday from NewOak Capital, observations by veteran investment banker David Eyzenberg pointed to another area in which we may be seeing a reality gap: CMBS underwriting and investors’ willingness to make a leap of faith. "The steady erosion of loan-to-value requirements and debt service coverage ratio standards is not as concerning as the reintroduction of pro-forma loans," says Eyzenberg, managing director and head of commercial real estate at New York City-based NewOak. "It is one thing to make a bet on what you know is there, but quite another to make bets on what may or may not be."

Eyzenberg notes that the CMBS market proceeds from the assumption that participants can discern value from the information available to them. With pro-forma loans, he writes, “the information upon which decisions must be made is not fact, but rather conjecture—a subjective model that materializes by assumption rather than observation. The problem comes when you have fixed-income investors trying to discern and properly evaluate the real estate assumptions made when pro-forma loans are funded."

The risks of literally banking on pro-forma assumptions are different today than they were at the market’s peak five years ago. Then, you had underwriting based on the assumption that the laws of gravity no longer applied and so what was going up would not come back down. Today, pro-forma underwriting may be based on the premise that market conditions will improve at a faster pace than what we’re actually seeing. Do you see a real hazard here, or do you believe that the participants in these deals are making prudent bets? Let us know.

(The Editor's Note in the June issue of our e-newsletter, Distressed Assets Investor, has more on fantasy pro-formas. Click here to read it.)