Following Basel III—a global, voluntary regulatory framework on bank capital adequacy, stress testing and market liquidity risk—U.S. banks have been reluctant to approve construction lending based on the concern that doing so may activate a requirement to retain increased capital on their ledgers. These domestic banks, however, are anticipating Trump’s potential rollback of some onerous regulations for the industry, which would likely result in a subsequent revitalization of their lending activity.
Still, the persistent lag in U.S. loan availability has led a significant number of real estate developers to seek funding from abroad. Foreign firms have responded accordingly by ramping up their U.S.-based lending activity after recognizing the lucrative opportunity to fill this finance gap.
Legal experts note that because U.S. banks that extend loans to real estate development typically factor in the added expense of maintaining more capital on their books, developers may save several percentage points in loan interest by opting for a foreign financier instead. This scenario is particularly true for the split between the initial mortgage and the given developer’s equity—the piece that’s usually the most expensive to acquire.
Both Chinese-based pre-existing funds and the country’s major banking institutions including Bank of China and Industrial and Commercial Bank of China have significantly escalated their U.S. real estate lending activity. Whereas construction loans from a U.S. bank typically costs developers anywhere from ten to fifteen percent, comparable plans can be obtained abroad for as little as six to ten percent. The Chinese government, however, has levied currency transfer restrictions in an attempt to prevent its investors from diverting their capital to the U.S. real estate market.
The reluctance of U.S. banks to extend construction loans stems from regulations under both the domestic Dodd-Frank Act and the international Basel III requirements. As a result, the majority of U.S. banks consider condo construction loans to be highly volatile per Basel III, which mandates that lending institutions must have an excess of 50 percent of capital on the books for any High Volatility Commercial Real Estate (HVCRE) loans.
There is a certain amount of uncertainty within the industry as to what triggers the HVCRE requirements, which has led U.S. banks to avoid approving loans destined for condo development plans. New hospitality construction projects are similarly experiencing difficulty in obtaining U.S. banking loans and have also turned to foreign firms willing to fund those much-needed projects.
Although Chinese companies have been particularly active, financial institutions from various other countries have ramped up their U.S. real estate portfolio as well, including major German financial players like Allianz and Deutsche Bank, who find the existing lending gap in the U.S. a viable alternative to the hyper-competitive German market. Additionally, European bankers, most notably Societe Generale, Deutsche, and Natixis, have been funneling capital into the commercial mortgage-backed securities (CMBS) lending marketplace—a significant number of which will be due in 2017.
Regardless of the increased foreign participation, the looming question is how much the U.S. banking industry will be deregulated under the Trump administration and what potential effect it will have on both domestic and overseas lenders. If there is deregulation, the momentum may shift to remove the current incentive for foreign banks to fund U.S. real estate projects.
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