News from the Appraisal Institute
The Appraisal Institute reported Nov. 12 that new loan risk
weight requirements that impact commercial real estate are
putting greater emphasis on the “as completed” value within
appraisal reports prepared for acquisition, development and
construction loans, known as ADC loans.
The Basel III accords, which took effect January 2014 for
larger banks and will take effect this January for all banks
with more than $500 million in assets, require financial
institutions to maintain higher capital levels and to hold more
capital for higher risk loans. The new rules may cause complications for new construction and development loans.
Previous rules treated nearly all commercial real estate
loans with a 100 percent risk weight, whereas Basel III revises
this risk weighting to a range from 50 percent for low-risk
loans to 150 percent for loans with the highest risk rating,
which are high-volatility commercial real estate loans for
acquisition, development and construction.
Some ADC loans may qualify for exemption if they meet
three specific criteria:
1. The loan has a loan-to-value of less than or equal to 80 percent;
2. The borrower contributes
capital to the project in the
form of cash or unencumbered marketable assets
of at least 15 percent of the
appraised “as complete”
3. The borrower’s capital is contributed prior to bank funding
and remains in the project throughout the life of the project;
a project is “concluded” once the credit facility is converted
to permanent financing, sold or repaid in full.
A 2013 report from advisory firm Ernst & Young noted that
the third exemption deviates from traditional bank credit
practice. Typically, the equity provided is 15 percent or more
of the project’s costs, and banks usually consider the current
value of developable land to count as the borrower’s “skin
in the game.” That scenario can cause credit availability
problems for developers who want to build on land previously
invested and held for development. It also may force some
developers to bring more money to the table to prevent the
lending institution from assigning the higher risk weight.
AI has heard from several commercial real estate lenders
about appraiser analysis of developer profit within appraisal
reports. Some have shared concern about overreliance on
rules of thumb and have expressed a need for more support for
profit along the development cycle.
There also may be a need for additional guidance from bank
regulators regarding vacant land used as equity in construction and development loans. Bank appraisal departments
have reported confusion over whether to use actual land cost
or its current value. Properties purchased many years ago
likely have appreciated since acquisition, although some bank
compliance officers (exercising an abundance of caution) have
suggested using actual cost.
Basel III accords scrutinize ‘as completed’ appraisal values
AI offers education courses that address
these issues, including Advanced Concepts
& Case Studies: