Despite the availability of capital, banks have pulled back on construction lending for a couple of reasons. Lenders are approaching construction loans more prudently because the market is moving into a more mature stage of the real estate cycle. Banks are also facing more regulatory pressure on high volatility commercial real estate (HVCRE) loans due to Basel III rules. Basel III rules require banks to hold 50 percent more cash reserves to account for anything that falls into the HVCRE category.
Most respondents (62 percent) believe that new construction loans will be the most significantly impacted by the new Basel III rules. In addition, nearly two thirds of respondents (63 percent) think the rules pertaining to high-risk commercial real estate loans will negatively impact banks’ willingness to issue commercial real estate loans. In fact, 26 percent said the rules could significantly decrease banks’ willingness to do commercial real estate loans. Thirty two percent anticipate no change and 5 percent believe that Basel III may increase banks’ willingness to issue commercial real estate loans.
The impact from the new HVCRE loan requirements is already being felt as the new rules have been in place for several quarters. Construction lending is certainly impacted as banks hold more capital against these loans, which are not yet stabilized. However, construction lending is impacted more by the market fundamentals and banks’ views on the supply and demand dynamics of the particular market and property type, according to Reid.
The majority of survey respondents think HVCRE rules will result in less favorable loan terms for borrowers, while 23 percent predict no impact and 6 percent believe the rules could result in more favorable terms. “They will become more conservative, most likely. But if the market is strong, lenders will inevitably begin to stretch to win business,” says Fiorilla. Respondents also anticipate that it will take several months for banks to completely adjust to the new rules. “The rules are probably going to keep evolving as the industry petitions regulators, so the process of adjustments could go on for years,” he adds.
Opinions were fairly evenly split on what sectors were likely to be most widely impacted by the HVCRE loans. However, multifamily rated the highest at 41 percent, followed by retail at 37 percent.