Source: National Association of REALTORS
While the broader economy is starting to turn around, the commercial real estate sector continues to struggle due to reduced operating income, property values, and equity. Additionally, commercial practitioners continue to experience difficulty in obtaining construction and land development loans, small business loans, short-term loans for capital improvements, and refinancing for mortgages.
Problems Impacting Commercial Real Estate Industry
Three main problems continue to negatively impact commercial real estate financing: bank liquidity, an equity gap, and a contraction in small business lending.
- Bank Liquidity…Plummeting commercial real estate values have forced many regional and community banks – a significant source for commercial real estate lending – to take steep write-downs, resulting in bank failures and a reduction in credit.
- Equity Gap…Over half of all commercial mortgages are currently “underwater” and many lenders are now demanding that borrowers come up with additional capital to cover this gap – especially problematic when a loan needs to be refinanced.
- Small Business Lending…Credit to the small business community has declined, leading to a decreased workforce and business failure. This has also elevated commercial vacancies, forcing prices to fall thus placing even more pressure on community banks and reducing credit – accelerating a negative economic cycle.
NAR Solutions
Accelerated depreciation–NAR endorses legislation aimed to help incentivize equity investment in distressed CRE properties by granting investors a one-time 50% bonus depreciation. At least 80% of the investment must be used to reduce the outstanding balance of debt, with the remaining going towards capital improvements. NAR supports the Community Recovery and Enhancement Act of 2011 (H.R. 1147), introduced by Reps. Nunes (R-CA) and Berkley (D-NV).
Basel III – The Basel Committee on Banking Supervision announced new, higher capital standards compelling banks to boost common equity requirements to 7% by 2019 to withstand future periods of financial distress. While the goals of the new requirements are commendable, NAR supports efforts to ensure that Basel III does not reduce liquidity in commercial real estate credit markets.
Credit union lending – NAR supports raising the cap of credit union business lending from 12.25% to 25% of total assets. Similarly, NAR endorses the Obama Administration’s proposal to raise the cap to 27.5% of total assets for well-capitalized credit unions. NAR supports the Small Business Lending Enhancement Act of 2011 (S. 509 – Sen. Udall (D-CO); H.R. 1418 – Rep. Royce (R-CA)).
Covered bond market – As credit markets continue to decline, the creation of a covered bond market in the U.S. will be essential to increase liquidity. Already in use in Europe and Canada, covered bonds represent a potential complementary funding source in the U.S. housing financial system as well as an alternative to securitization that could help address ongoing refinancing challenges in the commercial real estate sector. NAR supports the United States Covered Bond Act (H.R. 940), introduced by Reps. Garrett (R-NJ) and Maloney (D-NY).
Help banks clear their balance sheets of toxic assets – NAR believes that policy makers should pursue measures to encourage more private-equity investment in small financial institutions in order to turn around and recapitalize struggling banks and bring back much needed equity into the banking system.
Lease accounting
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have proposed new accounting rules that would force many companies to capitalize commercial leases onto their balance sheets. Larger balance sheets would force lessees to shorten lease terms to minimize costs. Since lessors raise financing by using the leases and the value of the property as collateral, the amounts they can borrow in the future could be reduced if lease terms are shortened. NAR will continue to combat these proposed accounting rules.
Mortgage insurance program – NAR supports legislation to create a mortgage insurance program for commercial real estate assets to cover the equity gap (the difference between the current appraised value of a property and the debt currently servicing the property) faced by many borrowers. The program’s structure would limit eligibility to properties found to be income-producing and viable in the long term. The insurance would also be for the short term and designed to cover the equity gap until the markets rebound.
Qualified Commercial Real Estate (QCRE) loans – The Dodd Frank Act requires entities that securitize mortgage loans to retain 5% of the credit risk. However, the law gives federal banking agencies broad authority to identify the acceptable types, forms, and amounts of risk retention for “low risk” commercial and multifamily loans. In response to the law, six banking agencies have proposed 0% risk retention for “low credit risk” or Qualified Commercial Real Estate (QCRE) loans that meet a series of extremely rigid underwriting standards. NAR believes the six federal regulators to withdraw, revise, and republish the rule for public comment because the rule: (1) it violates congressional intent of the Dodd-Frank Act, (2) unnecessarily defines the QCRE exemption from the risk retention requirements to include only a narrow slice of the mortgage market, and (3) jeopardizes the fragile commercial real estate market.
Small Business Administration commercial refinance program – NAR supports the extension of the Small Business Administration’s (SBA) commercial refinance loan program. This program provides an SBA loan for up to 40 percent of the appraised property value with no less than 10 percent of the remaining amount to be contributed by the borrower. This program only last until September 27, 2012 and is perfect for business owners that have equity in their property, but are having trouble getting credit. NAR supports the Small Business Administration 504 Loan Refinancing Extension Act of 2011 (H.R. 2950), introduced by Rep. Donnelly (D-IN).
Small Business Administration 504 and 7(a) loan programs – NAR supports making the SBA loan process less arduous for potential borrowers. NAR believes an extension to the SBA’s 90% guarantee as well as the elimination of loan fees will provide much-needed relief for commercial real estate practitioners as well as other small businesses. Additionally, NAR supports the inclusion of “non-owner-occupied” properties as part of the SBA’s temporary 504 refinance program.
Term extensions – For commercial borrowers that are making their monthly payments, a simple term extension in lieu of a refinance makes perfect sense. However, lenders are currently not offering these extensions due to pressure from bank regulators. NAR will continue to push the banking agencies to provide clear and consistent guidance related to commercial real estate loan workouts. NAR supports H.R. 1723, the “Common Sense Economic Recovery Act of 2011,” introduced by Representative Posey (R-FL).