The Commercial Real Estate Transaction Threshold: What's Changed; How it Affects You; What Lies Ahead
By Audrey Clearwater
December 10, 2018
Audrey Clearwater, Senior Vice President of Operations with LRES Corp., Orange, Calif., has more than 13 years of experience in the real estate and property valuations industry. She is currently responsible for overseeing LRES' residential and commercial real estate evaluation operations. In addition, she serves as LRES' subject matter expert in Interagency Appraisal and Evaluation Guidelines compliance as well as real estate evaluations. She previously served as Vice President of Operations for four years with InsideValuation before it was acquired by LRES in 2016.
Nearly 10 years have passed since the end of the Great Recession, and the banking industry is still adapting to the regulatory changes put in place to prevent its recurrence. An apprehensive public was vocal in its demands for greater transparency in real estate lending, and the government's response was swift and aggressive; putting highly publicized regulations into place in an attempt to rebuild consumer trust.
Risk management and compliance departments were soon growing at accelerated rates, helping financial institutions through the challenging work of restructuring lending operations to comply with a more complicated regulatory environment.
In the years that followed, rules that applied to residential real estate realized periods of adjustment, course corrections and fine tuning, but commercial real estate lending was left largely untouched. Spurred on by the decreasing number of available active appraisers and the continued increase in the quality and reliability of alternative products, significant changes have occurred for commercial real estate lenders, starting with loosening legacy limits on commercial real estate appraisal thresholds.
In this three-part series, LRES will present recent threshold changes as they apply to commercial lenders and discuss why these changes occurred, how they are impacting the commercial lending industry and where these changes may lead in the near future.
Change to the CRE Evaluation Threshold
The Interagency Appraisal and Evaluation Guidelines were originally established in 1994; at that time, the appraisal threshold was set at $250,000.
During the Great Recession, the cost of commercial appraisals began to increase to levels many considered prohibitively high for smaller regional banks, and turn times become so long that smaller lenders found it difficult to compete with larger financial institutions with the volume to attract appraisers and with the promise of steady work. Appraisers became so backlogged, the rural commercial real estate market essentially came to a halt. Lenders found themselves increasingly relying on evaluations as a reliable alternative to appraisals, but this strategy only addressed loan balances up to a $250,000 threshold; well below the norm for today's market.
In 2010, the IAG underwent a significant overhaul; however, the appraisal threshold was not adjusted despite the belief of many industry experts that it was outdated and not keeping pace with price appreciation. Lenders in more remote areas of the country banded together to call for change to the appraisal threshold under the Economic Growth and Regulatory Paperwork Reduction Act, which mandates federal financial institutions conduct periodic reviews of their rules "to identify outdated, unnecessary, or unduly burdensome regulations."
The Office of the Comptroller of the Currency; the Federal Deposit Insurance Corp. and the Board of Governors of the Federal Reserve (the Agencies) received more than 200 comments on both sides of the argument from appraisers, appraisal trade organizations, financial institutions and individuals. They conducted six outreach sessions across the United States, including some that focused on rural community banks. These outreach sessions collected the opinions of those who supported a change as well as those who opposed it.
As with most changes in this industry opinions were severely divided. There was little common ground between those who supported loosening the threshold on grounds that by doing so it provides the industry greater flexibility, lower fees, faster turn-times and reasonable safety and those who felt that it would only serve to undermine the safety and soundness of lenders which would in turn diminish consumer trust which was only just beginning to be rebuilt.
The Agencies compiled a summary of arguments representative of both sides and submitted a Joint Letter to Congress formally requesting the threshold laws to be adjusted to $400,000 for both commercial and residential real estate loans. This past April, Congress announced it rejected the threshold adjustment on residential transactions, but approved an increase to $500,000 on commercial real estate transactions. The FDIC formally published the change to the Federal Register on April 9, marking the first change of its kind since the previous threshold was established in 1994.
The real estate lending profession is notoriously unpredictable, but it is also an industry where change comes slowly. Many banks and lending institutions are still in the process of reviewing their risk policies and rewriting bank policy to support the adjustments. Others have remained steadfast in their resolve to order appraisal products regardless of the changes.
An important thing to keep in mind is that these changes are not requirements--they are allowable guidelines--and every lender must carefully consider what practices allow them to be competitive while still adequately mitigating risk.
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