Just before lawmakers returned to their districts for the Memorial Day break, the House passed and President Donald Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act. This reform legislation includes NAIOP-supported provisions that will ensure there is adequate capital availability for commercial construction financing.
Revision of the HVCRE designation is an important element of NAIOP’s 2018 agenda. That makes enactment of this legislation is a major victory for NAIOP’s members, as NAIOP President and CEO Thomas J. Bisacquino pointed out when he commended lawmakers and the president for enacting the reform.
Since 2015, banking regulators have been classifying certain acquisition, development and construction (ADC) loans as High Volatility Commercial Real Estate loans.
Under the HVCRE designation, banks were required to hold 50 percent higher capital reserves against these loans as compared to loans to other types of businesses. That made such loans more expensive for banks to keep in their portfolio. Once designated as an HVCRE loan, a bank was required to maintain higher capital reserves for the life of the loan.
These loans were typically exempted from the HVCRE designation if the loan-to-value ratio was less than 80 percent, and the borrower contributed capital of at least 15 percent of the project’s value. Under previous law, land counted toward this capital requirement but was valued at its initial purchase price, rather than at its present-day value.
The new law requires banking regulators to revise some elements of the current HVCRE designation that unfairly targeted commercial construction lending. For example, the new law will:
- Allow commercial borrowers to use the appreciated value of contributed land. This recognizes that many developers purchase land when it is less expensive and hold it for months or years before beginning to build on it. Under the prior rule, lenders were forced to value land based on what had been paid for it, ignoring any appreciation.
- Limit the application of the HVCRE classification in the case of loans made to acquire existing property with rental income. These loans will no longer carry higher capital requirements, as they did under prior law.
- Allow banks to remove the HVCRE designation prior to the end of the loan once capital requirements are met. This will help operators who’ve seen the value of their property appreciate – and who have achieved high rates of occupancy and a steady cash flow – to the point that their loan no longer requires HVCRE designation.
The reform was needed. Tougher HVCRE policies enacted after 2008 might have made sense if commercial real estate had been a major factor in the financial crisis. They also might have made sense if policymakers could credibly argue that greater restrictions are needed because lending to the CRE industry is getting out of control. But no such policy rationale exists for either case.
Commercial real estate didn’t cause the credit meltdown. And the Federal Reserve has found that banks are less exposed to risk through their commercial real estate loans today than they were in 2007.
The reform is also important because ADC loans from commercial banks are the largest piece of the almost $4 trillion in outstanding CRE debt. These loans are a crucial source of continued financing to the commercial real estate industry. The former HVCRE rule made it more expensive for banks to provide the financing for worthy real estate projects that are critical to continued economic growth. The new law should help improve this.
The new law will encourage stable capital formation and balanced and disciplined lending, and will help CRE support job creation, economic growth and investment in the U.S. economy. It’s an important victory, one that comes just a few weeks before lawmakers shift into election mode in advance of the November midterms.