Construction financing

HVCRE update

By | Commercial Real Estate, Construction financing, Regulation

Our prior article about the Highly Volatile Commercial Real Estate (HVCRE) rule that was part of the Dodd-Frank Act’s Basel III capital rule needs an update.

May 22, 2018, the unclear and illogical HVCRE rule was amended. It now allows land to be valued at a current appraised value! This is a huge and welcome change. Previous to that, contributed land value was valued based on the prior sale. The new rule states, “the value of any real property contributed by a borrower as a capital contribution shall be the appraised value of the property.” Hopefully, this will help regulated banks make more loans on commercial real estate for acquisition, development, and construction.

The new rule better defines an HVCRE acquisition, development and/or construction (ADC) loan. It also allows banks to make such loans without the 150% capital weight– a huge penalty for a bank.  And for borrowers, there would no longer be a 15% cash contribution requirement (because the land would be accepted capital) and once the property begins to produce income, that income could “taken out,” for example, to payback the project’s investors.

Tower Commercial Mortgage arranges $2.95M in Freddie Mac Financing for a 24 Unit Multifamily Asset in Salt Lake City Utah

By | Commercial mortgages, Commercial Real Estate, Construction financing, Multifamily housing
Multifamily apartments

SALT LAKE CITY, UTAH — Tower Commercial Mortgage through one of its capital partners, yesterday arranged permanent financing for $2.95 million in Freddie Mac financing. The financing was used to take out the construction loan for the newly built multifamily asset that was stabilized in 2017, located in the Salt Lake City area. The originated loan features a 10-year term with a 10-year floating rate extension and a 30-year amortization schedule. The sponsor completed the 24-unit property in August 2017, and the property was stabilized in December 2017. Tower Commercial Mortgage had arranged the construction financing previously to construct the property. The borrowers were not disclosed.

The sponsor approached Tower Commercial Mortgage two years ago to find construction financing for the project. The sponsor had been looking for two years and was unable to secure financing. Tower Commercial Mortgage was able to secure construction financing within six weeks.

Mike De Carlo, President of Tower Commercial Mortgage, said “We are thrilled with the outcome of this loan as the project was a very successful project and that the property’s sponsor couldn’t be happier.” He said, “Salt Lake City, Utah is rapidly growing and demand for housing is strong. There are many people moving in from outside the state, attracted to the many recreational activities the state of Utah offers. So new multifamily projects are necessary to keep up with the additional demand.”

#CRE, #CREfinance, #multifamily, #apartments

What is a high volatility commercial real estate (HVCRE) loan?

By | Commercial Real Estate, Construction financing, Regulation

Defined by federal regulators, an HVCRE loan is any commercial mortgage loan used to acquire, develop, and construct (ADC) commercial real property prior to a conversion to permanent financing as HVCRE where there was not at least 15 percent cash contributed by the developer. Watch out for this requirement on commercial mortgage loans that are considered high volatility commercial real estate. It’s just one of many insane rules bankers are having to comply with today. No wonder smaller banks are selling out to larger banks.

Banks must now hold 150 percent of their capital for all HVCRE loans—typically CRE loans are 100% capital weighted. The new rule went into effect back on January 1, 2015, but for whatever reason, banks are only recently (within the past year or so) rejecting loan requests that cannot meet the HVCRE requirements. The new rule is designed to protect the lender by increasing the developer’s equity cushion above the lender’s loan amount.


This could be a big surprise if you haven’t sought a commercial mortgage loan in recent years. The new requirement for obtaining a commercial mortgage has restrictions on the use of land as equity and regulators want to see 15 percent cash contributions from borrowers.

How it impacts developers

Here’s the biggest shock that will be a challenge. Your contributed capital into the commercial property must be at least 15 percent of the “as completed” appraised value in cash or unencumbered readily marketable assets! Yep, you heard that right; dirt, land, or ground isn’t of any value to bank regulators back in Washington, D.C. It should be noted that the “as completed” value is typically lower than the “stabilized value.”

In other words, what this means is, if you land banked some property for the past 20 years and now want to develop it and build a commercial building on it, you will have to demonstrate that you have paid in 15 percent equity of the “as completed” appraised value in cash or prove that the property was recently acquired with a sales contract showing what you paid for the property.

The other scenario where this would come into effect is you buy land and it appreciates while you are getting ready to raise debt. The bank would not be able to use that appreciated equity above what you paid for it.

Remember any and all cash into the project has to be documented, such as land purchase and soft costs. If you cannot show that what you paid for the property represents 15 percent of the “as completed” appraised value, the lender is now forced to ask you to pay cash or contribute unencumbered readily marketable assets (stocks and bonds, or cold hard cash) of 15 percent into the project before they lend a dollar.

For example, let’s say you found the perfect commercial project and use of your land that you have held for the past 20 years—say it was inherited. And let’s say it is now worth $750,000. You determine your construction budget will be $5 million. You think perfect, my land is 15 percent of the total costs and I have another 10 percent in soft costs and cash—thinking a LTC of 75 percent. So you call up your local banking friend and ask for a construction loan.

He says, sorry, we cannot accept that land as equity, so you will need to deposit $750,000 in the bank as collateral instead. And then, he looks at your balance sheet and says, hmm, you won’t have enough liquidity in your balance sheet after the deposit, so I am sorry, we have to decline your construction loan request. Huh?

Land isn’t considered tangible equity… Say what???

Why? It appears the regulators do not like to see a borrower requesting a commercial mortgage from a bank without having “tangible equity” in the project. Regulators would argue that one of the factors that led to the last financial crisis was borrowers claiming they had equity in a property (because of the land’s appreciation) when really the equity or capital they contributed was really just price appreciation. When real estate prices were moving up so fast that you could buy a property and within 6 months the property increased by 20 percent or more, that inflated price they would say is not really an equity contribution by the borrower. Ok, that’s understandable. But, shouldn’t the land still be worth something? In short, the regulators are arguing that the borrower didn’t really have any of their own capital or cash in the deal—no skin in the game.

A few exceptions

There are a few exceptions if the loan is secured by:

  • 1-4 family residential projects.
  • Properties that qualifies as a community development project.
  • Agricultural land

So basically, if you have a multifamily property that qualifies as a community development project for low to moderate income residents, then any bank that would finance the property would not be subject to this regulation. Unfortunately, this leaves out all other commercial properties that require financing. And of course, an SBA 504 loan may also be exempt from the HVCRE rule if it meets the requirements for community development and fits into the lender’s community develop act lending activities.

Therefore, real estate that does not have any tangible contributed capital is considered highly volatile commercial real estate. It is highly volatile because the borrower has not paid in enough of their own tangible cash. Apparently, there isn’t enough pain in the deal for the borrower. The borrower could theoretically walk away and not suffer a significant loss.

Of course, this is short-sighted at best. The regulators have not completely thought this through because they are not considering the value of the developed project—maybe “as completed” value but not the intangible value of creating something from raw, undeveloped land. The value of the end product as completed does provide skin in the game—not to mention the land contributed. Just ask anyone who lost their shirt during the financial crisis in 2008-2009 and they will tell you they did suffer some pain—even if they didn’t contribute 15% cash into the deal.

Banks must comply

Why do Bank’s care about this rule? First, they have to comply or be criticized by their banking regulators which can cause increased deposit insurance premiums, limit new branches, or limit any new products they might want to offer. Second, even if they made the loan, capital weight restrictions on the amount of the loan at 150 percent of the bank’s capital, reduces their already thin margins. 150 percent capital weight creates an additional cost of capital because it ties up 50 percent more capital that could otherwise be lent out to other bank customers. So, if they don’t follow all aspects of the regulation, bank examiners would likely criticize the bank for not following the regulatory guidance. Banks aren’t happy about this rule either, but it is the current regulatory environment they must operate in.

How can a borrower avoid being classified as HVCRE?

There are three conditions anyone of which triggers HVCRE:

1) The LTC is less than or equal to the maximum LTC requirements found in the Interagency Guidelines for Real Estate Lending. For construction loans, its 80 percent LTC, but most banks are lending at lower percentages.

2) The borrower contributes at least 15 percent of the “as completed” value of the property in cash or unencumbered marketable assets prior to any lender’s advance. Some banks are accepting soft costs as part of this contribution.

3) The borrower’s contributed capital and any capital generated is contractually required to remain in the project until the project is completed, stabilized, and converted to permanent financing.

If you’re looking to a bank for a construction loan and have held the property for a while, be prepared to show your skin in the game!

Good news!

We have non-bank construction lenders who aren’t under such silly regulations. Give us a call if you have banked some land years ago and now want to develop it.

Helpful links

This article isn’t meant to be legal advice and does not answer all the questions about the HVCRE rule. So if you want to learn more here are some links to the regulation, guidance Q&A and others interpretations.–US-Federal-Banking-Agencies-Release-Answers-to-FAQs.pdf


Six steps to keep your next commercial project out of trouble

By | Commercial Real Estate, Construction financing, New Construction

Community banks are ever monitoring and reviewing their commercial mortgage portfolios. These loans are typically their larger loans within the bank and as such get closer scrutiny from banking regulators. When local real estate markets run into trouble, the banks servicing commercial mortgages will be looking closely at each one for any signs of trouble. In addition, bank examiners will be looking closely at them as well.

So what are the signs that banks are looking for? How can you ensure that your commercial property associated commercial mortgage won’t end up as a troubled loan on the bank’s watch list? Well, sometimes there’s not much you can do when adverse economic developments tank the economy and cash flows on your property decline. However, here are some things you can do.

First, before you even invest in new construction, take a close look at the local commercial market. Ask yourself, is the market overbuilt? That is one of the first signs of future trouble for your project. Timing is important—sounds too simple, but it gets overlooked when everything in the economy is moving strong and fast. Even bankers get caught up in the euphoria.

Second, be sure you have done your homework on the project. Is there a market for the property? Is the project the right fit for the location? Is it the highest and best use for the location? Not having a sound feasibility study or analysis can lead to substantial problems later on.

Third, keep any selling or leasing concessions to a minimum. If concessions are being made to sell units or get lease commitments for a new project, it could be a sign of trouble if those concessions cause the cash flows to come in below the projected cash flows.

Four, stick to your plan if you did your homework. Making significant changes during the project’s construction can be very problematic. For example, if the project changes from a condominium to an apartment project.

Five, make sure you have adequate time to complete the project. Be realistic in scheduling enough time for each phase and make sure subcontractors are held to the schedule. In addition, be sure you have accurate cost estimates for each phase of the project. Construction delays or cost overruns can lead to renegotiated loan terms, something lenders look closely at as sign of trouble in the project.

Six, related to the previous step, make sure your construction draws are in line with your budget submitted to the lender. Periodic construction draws which exceed the amount needed to cover construction costs and related overhead expenses is a sign a project could be troubled.

Following these general steps will help your next project be a success. Lenders like to work with people who have sound plans for their project and are accurate with their cost estimates and market potential. Anything you can do to assure the lender that you have thought through and prepared sound plans will go a long way in obtaining financing for your new commercial property. We would enjoy discussing the financing for your next commercial real estate project. There is no cost or obligation until we find a committed lender will and able to finance your project.

How to get your construction loan approved.

By | Commercial Real Estate, Construction financing, New Construction

Before the financial crisis of 2008, community banks loved to hand out commercial construction loans. It was their core lending product. However, when developers had no good way of paying these loans back, banks suffered and it has since become harder to secure a commercial construction loan. Don’t get me wrong, banks love making these profitable loans because 1) they are short-term loans in which they can quickly get their funds back to lend out again, 2) credit unions are less able to make commercial loans due to restrictive regulations and 3) banks get points up-front on the entire loan amount—which typically acts as a line of credit, so the balance starts out small. But as I said earlier, if the economy turns south and the developer cannot arrange long term financing or otherwise pay off the construction loan, the bank is left with a loan that is not performing, or in other words, not being paid. Thus, the biggest source of strength the bank is looking for is a developer’s equity in the project at a minimum of 20 percent! Banks call this having skin in the game.

Most developers will call a bank first to apply for a commercial construction loan, and if they are turned down they’ll likely call a mortgage broker next. However, if you’ve been turned down as a developer, there are some things you can do to increase your equity in the project (because that is most likely why you were turned down in the first place, right?). So be sure to consider including the following when approaching a bank:

  1. Your cash down payment to purchase the land.
  2. If you used a land loan to purchase the land, do not include any principle and interest paid on that loan, because in theory the bank analysis will only treat the land as a cash purchase.
  3. All expenses paid-to-date into the project: architects fees, engineering fees, legal fees, etc. These should be included in the equity you are bringing to the table on the project.
  4. Any increase in land value since you purchased it.
  5. Any increase in the land value due to a zoning change.
  6. Any increase in value due to assemblage—from buying adjacent properties and combining them into one.
  7. Don’t break ground until you have been approved!

Remember, within this list are very valid non-cash items that add equity to the project! Don’t forget these because banks will first look for the 20 percent equity that you bring to the table before considering what you hope to do with the project.

Finally, remember that banks love to know that they are going to be paid back on time. The better that is communicated, the easier it is for them to approve the loan request. One advantage of working with a commercial broker to find the construction loan is that the bank also knows the commercial broker can find a more permanent commercial mortgage to take out the construction loan when the building is completed. In other words, you are more likely to be approved for your construction loan when you are working with a commercial broker because they will also find a permanent mortgage (and that makes the bank happy!). And when the bank’s happy, you’re happy and can spend more time to overseeing your construction project.