How Proposed Lighter Regulations Could Disrupt the Property Market
Bill H.R. 2148 of the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 made the regulations governing capital requirements for CRE loans less stringent. But what does this mean for the property market?
Basel III and the 2015 High Volatility Commercial Real Estate (HVRCE) Rule
Before we discuss possible consequences of the bill, it’s helpful to get some background on why lighter regulations were desirable in the first place.
In 2013, U.S. regulators introduced the Basel III regime, aimed at correcting the inadequate capitalization of banks, which had made them vulnerable to volatility in the global financial system and contributed directly to the financial crisis of 2008-2013.
As a part of Basel III, the 2015 High Volatility Commercial Real Estate (HVRCE) Rule established higher capital requirements than before for loans that financed the development, construction or acquisition of real property. Banks were required to carry a 150 percent risk weight, meaning that they had to reserve $1.50 per every $1 of capital for the life of a loan. For example, a $20 million loan had to be treated as a $30 million loan towards the lending institute’s total risk weight.
Since this made it more challenging for banks to finance loans, it severely limited credit availability for CRE borrowers; plus, it drove up the cost of bank loans, resulting in a constriction of the bank lending CRE market.
The 2018 Economic Growth, Regulatory Relief and Consumer Protection Act
On May 24, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act was signed into law. The Act includes Bill H.R. 2148, Clarifying Commercial Real Estate Loans, which lightens previous HVCRE regulations somewhat.
According to Commercial Property Executive, the Bill impacts HVRCE loans in the following manner:
- When a borrower’s capital contribution is 15 percent or more of the project’s completed value and a loan is under 80 percent of its completed value, the loan is exempt from the 150 percent requirement.
- The appreciated market value of a borrower’s equity in a property can be included towards the borrower’s capital contribution.
- Under condition that the 15 percent or more equity contribution in a property is maintained, borrowers can take cash distributions from it.
- A property can be reclassified as non-HVRCE ADC when the project is completed and generates sufficient cash flow to cover expenses and debt service.
Impact of Bill H.R. 2148
These adjustments are expected to have a positive impact on the bank lending CRE market. It will place banks at the same level as non-bank lending institutions such as debt funds, which aren’t subject to the 2015 HVCRE regulations and have therefore been able to offer lower interest rates for the past three years.
For banks, lighter risk weight regulations will free up the availability of credit and as a result, provide them with more incentive to offer loans, as well as make them more affordable. In addition, it will become easier for borrowers to meet HVCRE standards.
All these factors combined are likely to trigger an increase in CRE development, creating more jobs and resulting in a healthier, more competitive CRE market.
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