Under Increased Scrutiny, Lenders Adjust to Market Changes

Fourth Avenue and Columbia, Seattle, WA | Source: LMN Architects
Fourth Avenue and Columbia, Seattle, WA | Source: LMN Architects


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Several construction projects in Dubai and China will soon yield some of the world’s tallest buildings, and the U.S. is seeing a skyscraper renaissance of its own. New York City’s 111 West 57th Street is slated to be one of the tallest buildings in the country, at over 1,400 feet. In Seattle, the mega-skyscraper Fourth and Columbia is on its way up; and the Chicago skyline will soon welcome Wolf Point South, one of the biggest construction projects in the city’s history.

The building boom seems stronger than ever, but recently revised regulations and increased scrutiny around loans are changing how—and if—these deals are done. For lenders, new rules pertaining to high volatility commercial real estate (HVCRE) loans (money lent for the acquisition, development and construction of commercial buildings) have altered financing benchmarks; lenders must now meet, among other things, a 15 percent equity requirement on loans, or be subject to a 150 percent risk weight requirement.

In addition, a federal analysis recently revealed banks’ increasing tendency toward underwriting policy exceptions and a general lack of consistent oversight. As a result, top banking regulators in the U.S. advised all lenders to expect additional scrutiny. Banks that are expanding their commercial real estate lending activity or are operating in high-risk markets—like the notable, multi-billion dollar construction projects that have flooded prominent U.S. cities over the last few years—can particularly expect attention from regulators.

“A combination of new, more stringent regulations; concerns about the global economy, including China and oil prices; and realization of the perceived late point in this real estate cycle has led banks and others to become more conservative in their lending choices,” says Shawn Rosenthal, Executive Vice President of Capital Markets for CBRE.

This has forced lenders to either reduce activity, particularly around HVCRE loans, or change their focus.

“In general, we are seeing lenders cope with the scrutiny from regulators by being more conservative on…structure and hold positions,” said Michael Gigliotti, Managing Director at HFF, a real estate capital intermediary. “In some cases, we are seeing lenders pulling back from construction lending and focusing more on term loans.”

“These market conditions have allowed an alternative subset of lenders to fill some of this gap by writing large transitional or construction loans on their balance sheets and receiving premium pricing,” Mr. Rosenthal said. “We expect these participants to continue to pick-up market share. These sources include debt funds, hedge funds, private equity investors, select foreign banks and life companies.“

The good news, according to Ashley Grigsby, Managing Director of Finance at Transwestern Development Company, is that because the regulations are so broad, they are open to interpretation from each lending institution—leaving some doors open where others close.

“Developers need to research the way the lending institution they are working with is going to handle such things as distributions upon construction completion,” Ms. Grigsby said. “It is up to each bank to interpret the regulations, and they do not all interpret them in the same way. Just because a structure triggers HVCRE, it may not be a deal killer; it just may have a negative impact on pricing. However, if your leverage is in check, that might not be too problematic.”

How this shift in lending will affect the big picture of big building in the long term remains to be seen, but lenders know that things can change quickly—and sometimes for the better. Matthew Galligan, President of CIT Real Estate Finance, said this period of hesitancy is positive, as we would have otherwise overbuilt the market without it.

“Last year, a lot of lenders were giving the money away, now they are concerned…and it has caused them to look at their lending as more of a scarce resource and therefore allocate more carefully on a risk-return basis,” Mr. Galligan said. “If [developers] believe that [employment growth] will continue on a slow and steady basis, and interest rates will stay relatively low, then I think they can count on real estate continuing to grow.”




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