According to a recent report in National Real Estate Investor, a “day of reckoning” may be looming for banks with too much exposure on commercial real estate loans.
“Some industry observers are cautioning that there could be greater risk exposure emerging among some banks that has the potential to snowball into bigger problems in the event of a downturn,” the trade magazine reported.
K.C. Conway, director of research at the Alabama Center for Real Estate at the University of Alabama, is cited as saying “there is likely a ‘day of reckoning’ looming. He expects a test to come sometime in 2020.”
Conway, who is also chief economist for the Certified Commercial Investment Member Institute, said that banks are underwriting construction loans at 75 to 80 percent loan-to-cost and that, over a period of 24 months, rising costs could push the loan-to-cost close to 90 percent or higher, requiring developers to put in more equity when transitioning to permanent financing.
“I fear that the loan-to-value will be north of what the permanent market is willing to take it out at,” said Conway. In some cases, he noted, rising loan-to-cost levels during the construction cycle may result in the bank having to hold a loan on their books longer than anticipated. A loan might also have to be reclassified as a high volatility commercial real estate loan, which would require a bank to hold more capital in reserve.
Conway said he expects a challenge will come in 2020 when borrowers try to move construction loans to permanent financing.
Yet “banks are not likely to fall into the financial abyss as they did in the last recession,” Conway told the NRI. “The good news here is that this not going to be a 2009 type of real estate crisis, and banks do have more capital than they did then to absorb it.”