A rollback would make it a bit easier and faster to consummate a commercial real estate deal.
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How would a roll back of Dodd Frank impact the U.S. commercial real estate market?
We are a Chinese developer that has used U.S. banks for senior lending on two U.S. projects that we have undertaken. We have heard rumblings that the Trump administration might try and roll back aspects of Dodd Frank. If the Volker Rule was rolled back, would this increase lending? What other impacts would a roll back of Dodd Frank have on commercial real estate?
Answers
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It would depend on the size of the transaction. Dodd-Frank probably won't apply to smaller transactions. For larger transactions, the underwriting standards will most likely become tougher and loans will be scrutinized more. Rating agencies will be more measured in how they rate securities, possibly resulting in fewer securitizations and lower yields for investors. As for the Volker Rule, the effects there could be more limited liquidity in the commercial real estate market, which could result in raised costs and slower growth. Overall due to these changes, a borrower's ability to obtain a loan could become more challenging.
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Different regulatory rules have tightened lending. While there are the additional layers of reporting and compliance that affect banks, the primary thing hurting their ability to lend is liquidity regulations, both US led and under the Basel accords which impact the larger US and international banks. While there was optimism that the Trump administration would loosen those rules, it has not yet happened. The only proposals for lessening regulations to date will only impact smaller banks. The regulations result in requiring banks to hold more risk capital for real estate loans and particularly for construction lending. That has caused many of the typical suspects to curtail lending. On the debt side, non-bank platforms have burgeoned, to fill the opportunities left by banks retreating from riskier loans. Securitization has been growing steadily as well. The concern for borrowers is that platforms are looking for higher spreads, and prefer to lend into mezzanine positions to get higher returns. Platforms are making construction loans. Additionally, Asian Banks are a growing presence in the US markets and are more and more active. The other thing that will have an impact on loans is rising interest rates. Buyers are waiting for equity prices to drop, but interest rates will be increasing. The Volker rule doesn't restrain lending; it has impacted the ability of sponsors to co-invest significantly.
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It depends upon which parts, but in general more lending capital availability has been good for commercial real estate.
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I would not expect there would be much of an impact on foreign investors if there is a roll back of Dodd-Frank. This legislation, enacted after the financial crisis in 2009, was intended to bolster and protect US financial institutions from systemic risk, though many think the legislation went too far and did not properly or directly address the types of things that led to systemic risk. The main thrust of relaxation seems to be focused on reducing the impact of higher capital requirements and compliance with Basel III requirements on smaller banks and community banks, that were subject to the same requirements for maintaining capital, Basel III (which included HVCRE loan restrictions) and elimination of certain types of investment activities within the bank. The belief is that the roll back would permit smaller and community banks to resume real estate and other smaller business lending more along the lines of what they had done in the past without the burdens of higher capital requirements and HVCRE restrictions (high volatility commercial real estate loans, which include construction loans and other riskier real estate loans) that were typically made by these banks.
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As you know, the Volker Rule restricted the U.S. institutional lenders from making certain kinds of speculative investments that do not benefit their account holders. It is further argued that speculation of the transactions the institutions participated in were reasons for the 2008 financial collapse, which I believe it is 100 percent accurate. However, by implementing such high levels of restrictions to banks to provide leverage on U.S. developments, it minimizes growth and demand for new developments. I respect that certain restrictions in terms of LTVs / LTCs, sponsors equity vs. debt ratio, etc. should be in place. However, it should not be to the point that it is now. Only a very few U.S. institutional lenders are bullish on ground-up developments and predominantly in tier 1 cities (New York, Miami, Dallas, etc.). Having said that, they also have strict covenants in place with the developers in case of any macro-shock to the economy. When Dodd-Frank is rolled back, I strongly believe it would increase institutional lending; however, I still believe a firm structure should always be in place to protect both sides of the table to mitigate as much risk as possible in case of any future macro-shocks. The housing market in some major cities is going through a correction cycle at present, and I believe the next batch of new development with healthy capital stacks will come along in the next 24 to 36 months.
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