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Regulatory Framework Cuts Bank Capital for Commercial Deals in REALTOR® Markets

Based on the Expectations & Market Realities in Real Estate 2017: Intersection of Global Change report—released by Situs RERC, Deloitte and the National Association of REALTORS®—commercial real estate (CRE) investors took a step back during 2016. Large cap CRE sales volume declined by double digits on a yearly basis, with $489 billion in closed transactions during the year, based on data from Real Capital Analytics (RCA). Global economic conditions, political uncertainty and a stronger dollar were some of the reasons for investors’ caution.

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 2017 shines the spotlight on this significant segment of the economy.

Investment sales in small cap markets posted a solid trend line in 2016, with sales volume accelerating with each successive quarter. However, the first quarter of 2017 recorded the first yearly decline in four years. 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. However, the downturn in large cap markets may have a quicker echo in small cap counterparts.

In tandem with a slower rebound, capital liquidity in small cap markets also recovered at a slower pace, as debt financing comprised a much-larger portion of capital in small cap markets, whereas large cap deals benefit from significant equity contributions. Based on the 2017 report, the bulk of capital in REALTORS®’ markets flowed through regional and local/community banks, which accounted for 58 percent of transactions.

For regional and community banks, 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 2016 and the first quarter of 2017, resulting in tightening of capital. The report further indicates that 51 percent of REALTORS® reported that insufficient bank capital remains an obstacle to sales in small cap markets.

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The main reason for insufficient bank capital for commercial deals stems from financial regulatory uncertainty, which was cited by 28 percent of NAR members who specialize in CRE transactions. With a Republican Congress and White House, promises of tax reform and financial deregulation have yet to materialize. New and proposed legislative and regulatory initiatives were another important reason for insufficient bank capital allocated to CRE loans, comprising 26 percent of members’ responses. The third main reason was a combination of reduced net operating income, reduced property values and equity.

For the full report, access NAR’s Commercial Real Estate Lending Trends 2017 at https://www.nar.realtor/reports/commercial-lending-trends-survey.

George Ratiu, Director, Quantitative and Commercial Research

George Ratiu, Research Economist, writes regular economic columns and conducts research in the areas of commercial real estate, international investments, mortgage performance and foreclosures. He produces NAR’s Commercial Real Estate Outlook and manages quantitative surveys, including the Commercial Real Estate Quarterly Market Survey.

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