Lenders Feel Regulatory Pressure on Construction Loans |
Approximately 80% of FDIC losses during the “Great Recession” were due to nonperforming commercial real estate loans, primarily construction and bridge loans, which resulted in the creation of various regulations to prevent history from repeating itself. The High Volatility Commercial Real Estate (“HVCRE”) regulation within Basel III is one of the most prolific new mandates and requires lenders to hold 50% greater reserves for HVCRE loans (12% vs. 8%). As such lenders now have to reserve additional capital not initially budgeted when pricing the loans, which immediately increased construction lenders’ cost of capital. Construction loans can, however, be structured to avoid the HVCRE rule if 1) the sponsor invests cash equal to or greater than 15% of the as-complete value and 2) loan documents covenant that no distributions can be made by the partnership until the construction loan is refinanced out. The 15% cash requirement can be a difficult pill to swallow for sponsors who have owned land for some time and likely have significant imputed equity due to a low cost basis.
Although construction lenders have reacted to HVCRE’s introduction by tightening underwriting metrics and increasing pricing, each lender interprets HVCRE guidelines slightly differently. George Smith Partners’ deep and specific knowledge of the construction lending market allows Sponsors to adeptly navigate these headwinds and continue to source construction financing in these challenging times. Kyle Howerton
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