Regulations Hamper Bank Capital for Commercial Deals in REALTOR® Markets

Based on the Expectations & Market Realities in Real Estate 2016: Navigating through the Crosscurrents report—released by Situs RERC, Deloitte and the National Association of REALTORS^®—commercial real estate (CRE) rode a wave of bullish capital markets in 2015. Large cap CRE sales volume continued its positive upward trend, with $543 billion in closed transactions during the year, based on data from Real Capital Analytics (RCA). However, in the first quarter 2016 sales volume dropped 20 percent on a yearly basis, to $111 billion. Part of the decline is due to the large portfolio transactions which occurred during the first quarter of 2015, and which were absent this year. In addition, investors have reached for the “Pause” button, as concern over global economic growth and financial market volatility mounted.

In contrast to the large cap transactions reported by RCA, commercial REALTORS® managed transactions averaging less than $2.5 million per deal, frequently located in secondary and tertiary markets.  The Commercial Real Estate Lending Trends 2016 shines the spotlight on this significant segment of the economy.

The data underscore an important point about the recovery and growth in small cap markets.  Based on comparisons of vacancies, rents, as well as sales, prices and cap rates, the rebound in smaller markets was delayed by three years and the rate of price growth has been shallower.  Capital liquidity also recovered at a slower pace, as debt financing represents a much-larger portion of capital in small cap markets, whereas large cap deals benefit from significant equity contributions.  Based on the 2016 report, the bulk of capital in REALTORS®’ markets flowed through regional and local/community banks, which accounted for 56 percent of transactions.

For regional and community banks—which account for 56.0 percent of all capital in REALTOR® markets—compliance costs stemming from financial regulations have made a stronger impact on available capital for CRE deals. With higher costs of compliance and higher capital reserve requirements for CRE loans, regional and community banks have been more cautious in their lending during 2015 and the first quarter of 2016, resulting in tightening of capital. The report further indicates that 59.0 percent of REALTORS® reported that insufficient bank capital remains an obstacle to sales in small cap markets.

The main reason for insufficient bank capital for commercial deals stems from new and proposed legislative and regulatory initiatives—Dodd-Frank, lease accounting, carried interest, etc.—which were cited by 25.0 percent of respondents. Another 17.0 percent indicated that regulatory uncertainty for financial institutions was an important barrier to bank lending for CRE projects, tied with U.S. economic uncertainty. The third main reason was a combination of reduced net operating income, reduced property values and equity.

For more information and the full report, access NAR’s Commercial Lending Trends 2016 at http://www.realtor.org/reports/commercial-lending-trends-survey.