14A — July 15 - 28, 2016 — DelMarVa — M id A tlantic
Real Estate Journal
www.marejournal.com
D el M ar V a
asel III went into effect on January 1, 2014 for banks with more than By David L. Church, CCIM, U.S. Realty Capital, LLC Basel III - The Impact on Cash Equity for Construction Loans and a Major Unintended Consequence B
struction loan (ADC Loan). ADC Loans are assumed to have high risk; Basel III requires banks to set aside 150% of the regulatory capital required for non-HVCRE Loans. The need to set aside more capital has an impact on whether a bank will make an ADC Loan and at what pricing. By way of comparison, the only other loans subject to 150% of regulatory capital are those that are over 90 days past due. In order to avoid the categori- zation of a commercial construc- tion loan as an HVCRE Loan, banks will require a 15% mini- mum cash contribution by the borrower. The 15% minimum
cash contribution is based on the “as-complete” appraised value of the project being developed, not on the development cost or the development budget (the devel- opment budget differs from the development cost as it includes land at market value and a development fee). As a result, the developer will not know the amount of the minimum cash contribution until the bank has engaged an appraiser and ac- cepted the completed appraisal. Under the HVCRE rule, no ADC Loans were grand- fathered – this poses a par- ticularly thorny issue for banks where ADC Loans were booked
without “as-complete” values in the appraisals and where loan documents failed to include prohibitions against distribu- tions of “internally generated capital”. Without the appraisal data and the corresponding language in the loan documents, all ADC Loans would have to be categorized as HVCRE unless they were secured by 1-4 family dwellings, agricultural land or loans for “qualified investments” involving projects that provide community benefit. While this regulation increas- es uncertainty for all develop- ers, it penalizes developers who expected to use imputed land
value as most of their equity contribution. Although the origi- nal cost of land is considered cash equity, carrying costs on that land since purchase and the difference between cost and market value are specifically excluded from cash equity cal- culations. Additionally, the cash equity must be invested by the bor- rower prior to the disbursement of any loan funds by a bank and must remain in the project dur- ing the term of the loan. For an income producing property, the term of the loan ends when the construction loan is converted to a permanent loan. In addition, an ADC Loan that starts out as a non-HVCRE Loan may be con- verted to HVCRE if “internally generated capital” is distributed prior to repayment or conver- sion to a permanent loan. The prohibition against distributing “internally generated capital” is puzzling since it represents a return on capital as opposed to a return of capital – at least that is how the IRS would require a borrower to categorize it. Some construction lenders are willing to make HVCRE loans but the pricing will in- crease due to the higher level of capital required by regulators; the usual premium is 50 to 75 basis points. The willingness of a bank to make an HVCRE loan is likely contingent on a particular bank’s capital ad- equacy, the term of the loan and the perceived risk profile of a particular transaction. It is important for develop- ers to be aware of these Basel III requirements sooner rather than later so that alternative forms of financing can be inves- tigated. This falls under the “no surprises” rule. New regulations often pro- duce unintended consequences; in the case of Basel III, more cash equity is required for con- struction loans that have the least speculative risk: Project A is a build-to-suit of- fice building for a credit tenant that signed a 20-year lease; the “as-complete” and “as-stabi- lized” values are identical since the tenant will move in and com- mence contractual rental pay- ments as soon as the building is complete. Project B is a 100% speculative office building with a three-year lease-up; the “as- complete” value is significantly less than the “as-stabilized” value. Since the required 15% cash equity is dependent on the continued on page 18A
$50 billion in a s s e t s and went into ef- fect on Janu- ary 1, 2015 for smaller insti- tutions. The component of Basel III de- scribing High-
David L. Church
Volatility Commercial Real Estate Loans (HVCRE Loans) is of interest to commercial real estate developers because it defines an HVCRE Loan as an acquisition, development or con-
USRC provides Permanent, Construction, Mezzanine, Bridge, Joint Venture and Equity funding for Single or Multi-Tenant Office Buildings, Industrial and Flex Buildings, Apartments, Retail Buildings, Hotels, Self-Storage, for-sale projects and Other property classes. USCR also provides EB-5 debt and equity to qualifying projects.
AS A NATIONAL MORTGAGE BANKING FIRM U.S. REALTY CAPITAL WILL ORIGINATE OVER $1 BILLION IN DEBT AND EQUITY FOR CLIENTS THIS YEAR
U.S. Realty Capital Team
Riley J. Halloran, CCIM Charles K. Harmar H. Gerald Nanos Jane G. Bender
Robert A.C. Jacoby Bruce C. Robertson Richard L. Robertson David L. Church, CCIM
Eight Tower Bridge, 161 Washington Street, Suite 1525, Conshohocken, PA 19428 Phone: 215-893-9924 | Fax: 215-893-9830 | www.usrealtycapital.com
Made with FlippingBook flipbook maker