Monday
October 20, 2014

What Dodd-Frank Means for Commercial Real Estate

|
-A A +A

What Dodd-Frank Means for Commercial Real Estate

A conversation with Sabeth Siddique.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is intended to guard against the excesses that led to the economic crisis. But when it takes effect in July, it may also have some negative effects on financing of commercial real estate. (Note: NAR does not expect that all regulations will be written by the July deadline.) Sabeth Siddique, director of credit risk at Deloitte & Touche LLP and former assistant director for credit risk and banking at the Federal Reserve, talks about the possible implications.

Which parts of the Dodd-Frank Act will affect commercial real estate? There are two sections that are most pertinent in the bill: The first is the part that deals with risk retention of securitization, and the second is the Volker Rule, which limits affected banks from proprietary trading for their own accounts. Both of these provisions have the potential to reduce the amount of commercial real estate lending and to increase the cost of borrowing.

How do you expect the risk retention rule, which requires the issuers of securities to retain 5 percent of the credit risk, to affect commercial lending? Risk retention requirements will have a critical impact on the commercial mortgage-backed securities market and have a direct effect on how commercial mortgage-backed securities loans are issued and priced. Because they will have more skin in the game, CMBS issuers will use tougher underwriting standards and spend more time screening loans. That translates into a higher cost of lending and makes it harder for some higher risk borrowers to secure CMBS financing. The need to retain 5 percent of all loans also means banks could potentially have less capital to leverage.

In addition, Dodd-Frank requires credit rating agencies to analyze securities in more depth and to disclose their methods of due diligence. I think that’s going to make rating agencies more measured in how they rate securities. That will probably result in fewer securitizations and lower yields for investors because of more conservative investment structures.

Another part of Dodd-Frank that could have ramifications for the CMBS market is a requirement that federal agencies more carefully scrutinize any institution whose activities could pose a systemic risk to the financial markets. The continued uncertainty about the final rules remains a deterrent to CMBS market growth. The Crapo amendment to the final law, which requires regulators to consider the unique characteristics of the CMBS market, may mitigate some of these issues.

Would the risk retention rules in Dodd-Frank apply to small, private real estate securitizations? The Act probably won’t apply to small, private securitizations. However, market discipline may force them to have similar skin in the game requirements to those in Dodd-Frank.

How does the Volker Rule affect commercial real estate lending? The Volker Rule prohibits large banks from proprietary trading and from investing in hedge funds and private equity funds. The rule doesn’t prohibit banks from hedging to their own risk exposures. This proprietary trading limitation could affect the liquidity of the commercial real estate markets, which would ultimately raise costs and slow growth. It’s important to remember that the Volker Rule doesn’t apply to smaller community banks and will likely not affect many mid-sized regional banks, which hold large exposures to commercial real estate loans.

What can commercial real estate brokers and investors do, if anything, to reduce the impact of Dodd-Frank on their businesses? Borrowers in the higher risk spectrum may find it more challenging to obtain bank loans under Dodd-Frank. At the same time, Dodd-Frank attempts to ensure a level of cash flow and asset quality that will support securitization. Commercial real estate practitioners can play a key role in helping investors select fundamentally sound real estate assets and in managing those assets for an appropriate return.

0
No votes yet
Your rating: None