** UPDATE: The Federal Register notice appeared on July 31, 2017, thus opening up a public comment period that closes on September 29, 2017.
As many as 4,040 commercial real estate loans could be exempt from appraisals
This week, three bank regulatory agencies announced their latest response to concerns about the time and cost pressures of completing real estate transactions. The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency agencies are jointly issuing a notice of proposed rulemaking to raise the threshold requiring commercial real estate appraisals from $250,000 to $400,000.
Why the Change?
Revising the threshold is one outcome of the regulatory review process conducted as part of the Economic Growth and Regulatory Paperwork Reduction Act, which requires federal banking agencies to conduct a review of their rules at least every 10 years to identify outdated or unnecessary regulations.
In March 2017, the bank agencies issued a Joint Report to Congress detailing their review of rules affecting financial institutions, summarizing comments received from industry stakeholders and describing several joint actions planned or taken to reduce regulatory burden, including:
- Simplifying regulatory capital rules for community banks and savings associations;
- Streamlining reports of condition and income (Call Reports);
- Increasing the appraisal threshold for commercial real estate loans; and
- Expanding the number of institutions eligible for less frequent examination cycles.
During the most recent EGRPRA review, commenters raised concerns related to the current appraisal exemption threshold, including:
- That the $250,000 exemption had not kept pace with price appreciation in the commercial real estate market.
- That the time and cost associated with the appraisal process imposes an unnecessary burden on smaller transactions.
- Bankers in rural areas face delays in completing transactions given the difficulty of finding state certified and licensed appraisers in these parts of the country.
Among the organizations that submitted comments were the American Bankers Association and the Independent Community Bankers of America. Arguing for an even higher $500,000 trigger in a letter to regulators last year, ICBA specifically cited the need to reflect the rising costs of real estate since 1994, particularly in many urban markets. Appraisal industry advocates, including the Appraisal Institute, oppose the increase and are encouraging the agencies to maintain the current threshold.
“The agencies considered the appropriateness of the existing appraisal thresholds in the context of the comments received and the agencies’ prudential standards for safety and soundness. The agencies also gave special consideration to the issue of appraiser shortages in rural areas.”
~Federal Financial Institutions Examination Council, Joint Report to Congress, March 2017
Appraisals vs. Evaluations
If finalized, all transactions with a value of $400,000 or less (as well as certain real estate-secured business loans with a transaction value of $1 million or less) would not require appraisals. Transactions exempt from the appraisal requirement would instead require financial institutions to obtain an evaluation.
“For commercial real estate transactions with a value at or below the proposed threshold, the amended rule would require institutions to obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices if the institution does not obtain an appraisal by a state certified or licensed appraiser.” ~Notice of Proposed Rulemaking, July 2017
Under the Interagency Advisory on Use of Evaluations in Real Estate-Related Financial Transactions, evaluations:
- Are less detailed than appraisals.
- Do not need to be performed in accordance with USPAP or by certified or licensed appraisers, but should be performed by “persons who are competent and have the relevant experience and knowledge of the market, location and type of real property being valued. Evaluations may be completed by a bank employee or by a third party.” (Note: Some states also require that appraisers deliver/sign off on the value conclusion in evaluations.)
- Provide a market value estimate of the real estate pledged as collateral.
- Do not need to be prepared only by using sales of comparable properties to estimate market value. For areas where comparable sales are in short supply, that evaluations may use other valuation approaches (see the March 2016 guidance referenced under FOR MORE INFORMATION below).
A financial institution may also go beyond the requirements of the agencies’ regulations to require an appraisal in certain instances (e.g., when the institution’s portfolio risk increases, on higher-risk real estate-related financial transactions, etc.). The latest guidelines recommend that institutions develop policies and procedures for identifying when to obtain appraisals and when/how evaluations should be used.
What It Means for CRE Lending Community
- The FDIC estimates that the proposed rule will affect approximately 1,504 to 4,040 loans per year. Based on an analysis of data from the CoStar Comps database, the agencies determined there would be an 11 percent increase in the percentage of transactions exempt from appraisals:
“The percentage of commercial properties with loans in the CoStar Comps database that would be exempted from the Title XI appraisal regulations by the threshold would increase from 17 percent to 28 percent if the threshold were raised from $250,000 to $400,000. However, the total dollar volume of loans for commercial properties in the CoStar Comps database would only increase from 0.7 percent to 1.5 percent.” ~Notice of Proposed Rulemaking, July 2017
- The new threshold could also result in shorter closing times for smaller loans, especially for institutions in more rural areas with a shortage of appraisers:
“The agencies estimate that, on average, the review process for an appraisal would take approximately 40 minutes and the review process for an evaluation would take approximately 10 minutes. Thus, for affected transactions, the proposed rule would alleviate approximately 30 minutes of employee time per transaction, in addition to the reduced delay and the cost savings of obtaining an evaluation instead of an appraisal.”
- Business borrowers, particularly small businesses, would likely experience a decrease in borrowing costs:
“The cost of third-party evaluations of commercial real estate generally ranges from $500 to over $1,500, whereas the cost of appraisals of such properties generally ranges from $1,000 to over $3,000. Commercial real estate transactions with transaction values above $250,000 but at or below $400,000 (affected transactions), are likely to involve smaller and less complex properties, and appraisals and evaluations on such properties would likely be at the lower end of the cost range. This third-party pricing information suggests a savings of several hundred dollars per affected transaction…The proposed rule could reduce loan origination costs for borrowers by $1.5 to $4 million on average per year.”
The notice of proposed rulemaking was published in the Federal Register on July 31, 2017. Interested parties have until September 29th to submit comments on the proposal. If adopted, the new threshold will become effective on publication of the final rule in the Federal Register.
FOR MORE INFORMATION
- Notice of Proposed Rulemaking Jointly Issued by the OCC, FDIC and Federal Reserve, July 18, 2017, Federal Register notice
- Interagency Advisory on Use of Evaluations in Real Estate-Related Financial Transactions, March 2016: Addresses public comments and clarifies current supervisory expectations regarding evaluations.
- Federal Financial Institutions Examination Council, March 2017 FFIEC Joint Report to Congress: Summarizes comments related to changing the appraisal requirements, received from more than 160 bankers, banking trade associations, associations of appraisers and other sources.