Economists Weigh In: The Effect Of Stricter Capital Retention On Real Estate
Stricter capital retention requirements—from the Fed, Dodd-Frank and the Basel Committee—have come into effect since the crisis or are going to in the near future. Bisnow asked these four top economists what the effects (if any) of higher capital retention will be on commercial real estate markets.
Jack Kern, Director of Research and Publications - Yardi
"There has been a great deal of controversy over the impact of both Dodd-Frank and certain actions due to Basel agreements. I suspect that there are really cogent arguments for both sides of the issue. In my viewpoint, I think these kinds of actions are going to have a number of likely impacts, mostly interfering with investment banking in commercial real estate. The first and most evident one now is the tightening of credit for most project types. It is getting harder for most owners to refinance and construction loans may be a casualty in a lot of places. The increased reserve requirements in the banks, which is understandable, simply pushes the risk profile onto the borrowers and strains the lending limitation of the banks. Since the FDIC has a vast amount of power of how banks operate, all of the national banking companies are going to adhere strictly to the newly adopted regulations.
Other sources of capital, most likely not as affected by these changes, will see some boost in activity. Probably the life companies, wealth funds and private equity will retain some level of business.
In many respects since the commercial real industry is seeing some slowing, the impacts won’t be as immense as they might have been a year ago. There is still sufficient capital for most typical transaction types but unusual situations (size, location or complexity) are going to have a tough road ahead."
Ray Torto, Harvard Lecturer, Retired Global Chief Economist at CBRE
"I think the capital in this cycle is more equity capital than debt capital, meaning buyers have more skin in the decision process. Additionally, debt covenants are stricter at the moment and regulators are “at attention” because of the laws and regulations that you cite. From the market view, I think there is no effect as equity capital replaces the limited debt capital. From the view of certain players in the industry, clearly there are those whose businesses will be changed somewhat dramatically. Nevertheless, there is lots of capital looking to buy into commercial real estate, and the since the overall market is rather small and expanding quite modestly. To me, the implication is higher pricing as the decade winds up. The bigger question to me is whether this equity capital, which is now moving into development, rather than purchasing, will be more disciplined in initiating new development. Or will we see similar boom cycles as in the past, but with different capital drivers?"
Jamie Woodwell, VP of Commercial Real Estate Research, Mortgage Bankers Association
"Changing regulations and capital requirements are having a bigger impact on commercial and multifamily mortgage markets than they have in decades. Most directly, changing capital requirements are forcing some lenders to hold more overall capital for the loans they make, making that business less attractive and potentially reducing overall levels of lending from what they might otherwise do (or increasing the cost to borrowers). To the degree capital requirements differ for different types of lending, the extra costs can also push lenders towards some types of loans or loan features and away from others. We are seeing this play out as the recent high-volatility commercial real estate (HVCRE) rules affect new acquisition and development loans. The most complex—and perhaps impactful—of the changing capital rules comes where they interact with other regulatory changes. This can be seen in the commercial mortgage backed securities (CMBS) market, where new risk retention rules are pushing securities issuers to hold certain parts of the structure at the same time new capital rules are making doing so much more expensive. The market has only digested a portion of the changes, which are likely have increasing impacts the remainder of this year and into the future."
Robert Bach, Director of Research – Americas, Newmark Grubb Knight Frank
"Liquidity remains strong across the capital stack. Bank lending is up from a year ago, but loan terms have tightened due to stricter regulatory requirements for HVCRE (high-velocity CRE) loans. Life companies, REITs and private investors remain very active, while CMBS issuance has fallen due to rising risk in financial markets. Crowdfunding is growing quickly but is a small portion of the total and hasn’t been vetted in a down cycle. Regulators hope tighter lending controls will reduce the peaks and valleys in the CRE cycle by restraining the typical excesses of construction and pricing. I think they’ll be proven right."