The Commercial Real Estate Transaction Threshold: Causes, How it Affects You and What Lies Ahead
By Audrey Clearwater
April 1, 2019
Audrey Clearwater is Senior Vice President of Operations for LRES Corp., Orange, Calif. She has more than 13 years of experience working in the real estate and property valuations industry and 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.
Clearwater previously served as the Vice President of Operations for four years with InsideValuation before it was acquired by LRES in 2016. Prior to InsideValuation, she fulfilled roles in property management, vendor services and client management.
LRES is a national residential and commercial mortgage services company providing valuations, REO asset management and HOA services for the mortgage and real estate industry. With more than 15 years of continued growth, LRES offers managed business processes for the origination and default markets. For more information about LRES, visit its website at www.lres.com.
This is the second of a three-part series.
In our previous article, The Commercial Real Estate Transaction Threshold: What's Changed; How it Affects You; What Lies Ahead, published in MBA Insights on December 10, 2018 (https://www.mba.org/publications/insights/archive/mba-insights-archive/2018/the-commercial-real-estate-transaction-threshold-whats-changed-how-it-affects-you-what-lies-ahead?_zs=WqkwB1&_zl=k5Rn4), LRES Corp. explored the impact of commercial appraisal threshold change. Part one discussed initial changes approved by Congress in April 2018; this second part examines new changes imposed by the Small Business Administration, as well as significant residential changes that are still waiting for approval.
Ever since the Federal Deposit Insurance Corp. published a press release on April 2, 2018, announcing the federal banking agencies' decision to increase the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $500,000, the move has been a divisive topic in the real estate lending industry.
The threshold was originally set in 1994; proponents of the change, driven in part by the difficulty in obtaining real estate values in rural America, maintain that it had failed to keep pace with price appreciation. Those in opposition argue that raising the threshold will put American consumers at risk, and ultimately undermine regulations that were put in place to prevent economic collapse. Meanwhile, industry veterans predict the increased threshold can be a catalyst for other regulatory changes, and that paired with a culture of deregulation in Washington, such additional changes may occur faster than the industry can adjust.
When the threshold increase was first announced, the FDIC estimated only 1,000-4,000 loans would be affected by the change each year, but an apprehensive industry braced for much more substantive and impactful numbers.
Notably, commercial lenders that backed their small business loans via the Small Business Administration's 7(a) program experienced marginal change, as the SBA threshold remained $250,000. Echoing the FDIC's early projections, national valuation firms experienced minimal shifts to their evaluation products, and the initial fervor soon began to ebb. However, in July 2018, the SBA proposed a bill to Capitol Hill to match the agencies' change and adopt an appraisal threshold to $500,000. Encouraged by the perceived success of the initial threshold adjustment, Congress approved the SBA bill, and it was ultimately signed into law by President Trump in December.
While none of these changes yet affect residential real estate lending, there are two critical proposals now under consideration that could. Last October, the National Credit Union Administration board invited the public to comment on a proposal to raise the appraisal threshold from $250,000 to $1 million for properties located in rural areas. Remarkably, its proposal does not distinguish between residential or commercial real estate, leaving the possibility open for credit unions to use alternative valuation solutions for residential loans with values up to $1 million.
Some industry analysts are fearful that such a dramatic change, if adopted, would create inconsistent regulatory standards between banks and credit unions; and they are pushing the Federal Financial Institutions Examination Council and other participating agencies to enact consistent standards. Meanwhile, the Credit Union National Association, who advocates on behalf of the nation's credit unions, has come out in enthusiastic support of the proposed threshold increase, stating that prudent supervisory oversight should offset any potential risk.
Even while the credit union industry continues to debate a substantial threshold increase, the federal banking agencies are once again soliciting public comment on a proposed residential appraisal threshold increase from $250,000 to $400,000. This adjustment was originally included in the 2018 proposal, but it was ultimately rejected in favor of implementing only the commercial adjustment. Assuming the results of the public comment period are positive, an official joint letter to Congress requesting a formal residential threshold increase is likely to follow.
While these appraisal threshold increases could represent one of the most significant changes the lending industry has seen in a very long time, it is important to remember that they are not mandatory.
Ultimately, each institution is responsible for mitigating its own risk, and the appraisal threshold alone is not enough to adequately determine which valuation product should be used for a loan. When it comes to property valuations, a full appraisal will always be considered the gold standard; however, there is no argument that alternative valuation products have proven to be useful tools as well. Additional factors, such as the complexity of the property itself, the creditworthiness of the borrower, and internal bank policy must also all be considered when determining the best path forward for securing the value of a loan.
There is an ancient saying that "the only constant in life is change," and it has never been truer for the real estate lending and valuation industry. LRES will continue to monitor these ongoing changes closely, and part three of this series will examine what changes were adopted and how they will shape our industry for the future.
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