Construction Loans Fall Victim to Concentration Risk Concerns

Construction Loans Fall Victim to Concentration Risk Concerns

Capital is still free flowing for most borrowers. Yet some banks are taking their foot off the gas pedal for apartment construction loans in select markets where there are growing concerns of concentration risk. Banks are cautious about over-exposure in the wake of a prolonged apartment building boom. Some lenders are concerned about their bank’s exposure in that asset class and potential overbuilding risk. “We have found it more difficult to get construction loans done over the last 12 months,” says Gerard Sansosti, executive managing director at HFF, a capital markets services firm.

Basel III requirements related to high volatility commercial real estate loans (HVCRE) have also played a role in some tightening on construction loans due to increased capital reserve requirements. However, in most cases, the regulatory requirements are having a bigger impact on loan-to-cost amounts that banks are willing to extend and loan pricing, notes Mark Strauss, a partner and managing director of capital markets/equity practice at Cohen Financial.

The pullback on apartment construction loans is most noticeable in those markets around the country that have seen a spike in construction over the past three to four years. Austin is one market where it is harder to get construction loans done these days, says Strauss.

Since 2011, Austin developers have added more than 32,000 new apartment units, with another 11,400 units that were proposed or underway as of the second quarter, according to brokerage firm Marcus & Millichap.

Population and job growth have resulted in a notable surge of development activity in about a dozen metros across the south, as well as on both coasts. “There are some lenders that are restricting new construction loans in those markets until they see their existing loans pay off and until they see the absorption and rent levels that have been projected for those complexes achieve their [pro formas,]” says Strauss.

HFF has arranged financing for a number of multifamily projects in Pittsburgh. “For the most part, those banks are saying, ‘Let’s see how these loans do before we jump into another one’,” adds Gerard.

It is no surprise that banks are hyper-sensitive to concentration risk in the wake of the Great Recession. Regulators are also paying close attention to bank concentration risk. “What we have heard is that the regulators have been keeping an eye out for banks that have been growing their commercial real estate books particularly quickly and/or have large concentrations,” says Jamie Woodwell, vice president, commercial real estate research, for the Mortgage Bankers Association (MBA).

Federal regulators put banks on notice last December that they were going to be taking a closer look at commercial real estate loan concentrations in a joint statement on “Prudent Risk Management for Commercial Real Estate Lending” issued by The Federal Reserve along with other federal bank regulators. Regulators expressed concern about the “rapid growth and increased competitive pressures” in commercial real estate lending.

The statement did not communicate any new regulatory expectations, but rather was intended to remind the industry of the existing regulatory expectations and guidance for commercial real estate risk management practices. The Fed, FDIC and the OCC have said they will take an extra close look at institutions where total commercial real estate/multifamily loans, excluding owner-occupied properties, represent 300 percent or more of the bank's total risk-based capital.

Regulators are not saying that banks should not exceed that level. They are signaling that if banks get to that level, then they want to make sure those banks really understand their commercial real estate book of business, says Woodwell.

It is under that larger regulatory shadow that individual banks are implementing their own internal practices and policies to manage concentration risk for multifamily and commercial real estate loans. “I would say that institutions are always looking at their portfolios and looking where those different property types and geographies might be in terms of the cycle,” says Woodwell. Yet MBA data shows that lending is strong, and commercial and multifamily originations for the first half of 2016 were right on pace with the same period last year.

“As far as permanent financing is concerned, we haven’t really seen anybody take their foot off the gas relative to concentration issues,” notes Gerard. Those lenders that have slowed lending a bit on the permanent lending side are doing so because they are getting close to allocations for the year.

“Although no one is really out of the market, some people have become a little more selective on the transactions that they are going to do that will close before year-end,” he says. “They want to make sure that they have money available for their very best clients.”

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