In his recent testimony before the House subcommittee of the Committee on Financial Services, Jon D. Greenlee, an associate director of the Federal Reserve, said “Prudent real estate lending depends upon reliable and timely information on the market value of the real estate collateral.” He says this position “has been a cornerstone of the regulatory requirements for real estate lending and is reflected in the agencies’ appraisal regulations.”
While collateral valuation is not the only factor in a bank’s willingness to extend credit, it is certainly one of the most important underwriting considerations. A good appraisal that takes into account appropriate market data including applicable sales is the cornerstone of a lender’s underwriting package.
Unfortunately, Greenlee says that, “Given the lack of sales in many real estate markets and the predominant number of distressed sales in the current environment, regulated institutions face significant challenges today in assessing the value of real estate.”
Much of the guidance for dealing with troubled real estate borrowers coming from banking regulators is based on appraised values, but values based on distressed sales are not likely to be particularly helpful to bankers or borrowers.
So what are we to do?
Greenlee says that lenders should have “appraisals or other market information that provide appropriate analysis of the market value of the real estate collateral and reflect relevant market conditions, the property’s current ‘as is’ condition, and reasonable assumptions and conclusions.” Larger markets are tracked by several national brokerage concerns and such market information is readily available, but Louisiana markets are not as widely followed due to their size and market information is harder to come by. The Baton Rouge and New Orleans markets are fortunate to already have good sources of information, such as the Baton Rouge Trends publications, LSU and UNO market studies, and various apartment reports, but other markets within the state are not as fortunate. And as distressed sales data creeps into mix, it will be more important than ever to differentiate that data from market rate or “arms length” data upon which new loan decisions should be based.
Market participants across the state will have to band together to improve the quality of market information, such as is done in Baton Rouge with the Trends publications scheduled for presentation in April, in order for lenders to have the most accurate information for use in making lending decisions. While it might go against the nature of the highly competitive players in the market, cooperation in sharing data might be the best practice for the foreseeable future.
Read Greenlee’s entire testimony here.
(Brian Andrews is a certified mortgage banker specializing in the financing of commercial real estate. His business is Andrews Commercial Mortgage and he can be reached at brian.andrews@acmla.com.)
