Banking Rules & Regulations of the Day

Where we stand and where we’re heading in the world of U.S. banking regulations
By Richard Hill Adams

In light of the serious impacts they’ve had on the real estate industry, a Bill was recently put before Congress to revise and eliminate some of the draconian issues of the Dodd-Frank regulations. There had been talk of re-regulation and/or eliminating those prior rules to help the real estate and banking industries moving forward.

However, as is the way of best-laid plans, we now have the issue of Wells Fargo to contend with. Wall Street reform, action on the Consumer Protection Act, and the proposed legislation aimed at killing the Dodd-Frank regulations will all now come to a dramatic halt. There will be a renewed emphasis for the consumer watchdog, The Consumer Financial Protection Bureau. Legislators and their constituents will now believe that it is essential to further scrutinize banks and lending at all levels. None of this is good for the real estate industry.

Janet Yellen, chairperson of the Federal Reserve Board, recently stated that short-term interest rates need to increase. However, the economy is still mired in slow growth, despite the rise in U.S. Household Median Income of 5.2 percent in 2015 to $56,516 (still below the 2007 average). The Federal Reserve Board will point to this growth and use it as a pretext that the economy is not dependent upon low interest rates any longer, thus giving rise to the opportunity to increase short-term rates.

Today the housing market reports show that the run-up in home prices and sales growth has legs that will persist into 2017. Income growth is a fundamental driver of buyer demand. That being said, buyers must be capable of meeting the requirements for credit – debt to income ratios with commensurate down payments – to be able to buy homes. Underwriting on real estate loans for borrowers by lenders is an intricate process in today’s world where nothing is taken for granted, everything is subject to review, and loans are still hard to obtain.

To compound the problem, there is the issue of fewer first-time buyer homes being built and fewer resale homes in the market. This allows for people to sell and trade up. The majority of builders are preferring the more profitable second- and third-time, move-up buyer, versus the bare bones, entry-level product for first-time buyers that was built during prior recoveries.

Still, it is a recognized fact that new homes are not being built at the velocity of prior recoveries. Construction and development of new real estate projects has been seriously constrained by regulations and how banks focus their C & D lending activity.

Financing has been harder to obtain this year and will continue to be difficult in certain sectors. High Velocity Commercial Real Estate (HVCRE) rules have made it much more difficult to get financing for new developments. HVCRE rules have added complications in the commercial sector as well, due primarily to the Risk Retention Requirements. These requirements go into effect later this year, yet they are already having an impact on the CMBS market. Obtaining real estate financing in Tier 1 markets has been the goal of every lender. However, the interest rates are higher, loan-to-cost numbers for construction are lower, and the loan-to-value numbers are lower as well. In the permanent lending market, financing for a multifamily, Tier 1 property is at 3.5 percent. Contrast that with a tertiary market or Tier 3 and it is a 4.5 percent interest rate – a clear, one-full-percentage-point spread.

On the construction side of lending, the reserve requirements for banks are significantly greater due to the re-regulation of the banking industry. The big winners in this scenario are the private capital companies that have stepped in to fill the gap, providing land and land development loans for new construction projects. In some cases we’ve seen land loans as high as 75 percent loan-to-value from the private capital companies. Regulated lenders will discuss 40 to maybe 50 percent loan-to-value transactions for existing, well-heeled customers.

Multi-family product is still the darling of the lending industry, due to the ability of government agency permanent financing, be it Fannie Mae, Freddie Mac, or FHA. When the multifamily product has reached completion and has been 90 percent occupied for 90 days, with income in place to service the debt, it is easy for the construction lender to have this loan paid off, thus providing new opportunities to make more loans. However, in some markets, over-building is starting to appear.

Regardless, construction will still continue forward, major, publicly-traded building companies will have great opportunities due to the breadth of their organizations, their capitalization, and their ability to finance from Wall Street or major lenders. Midsize to smaller independent builders will have a much more difficult path with less lenders in the market and tighter lending requirements; it will be harder to obtain the financing which is desired for their new projects.

If the projects are large enough and the builders have significant net worth and credibility, they should look to the International Banks, which are regulated differently than U.S.-based banking institutions. The international banking community has more room and more capacity to put on construction financing, and they have not constrained their C & D lending to the same extent as U.S. banks. We live in interesting times, and will continue to see more regulation, lender scrutiny, and significant constraints in the real estate lending markets as we move forward.

Richard Hill Adams is the Chairman and Chief Executive Officer of American Realty
Capital Advisors. He may be reached at

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