The federal banking regulators proposed an increase in the threshold for commercial real estate transactions requiring an appraisal from the current $250,000 to $400,000, a move the agencies said was in response to “concerns about the time and cost associated with completing real estate transactions.”
What happened
As part of the review process mandated by the Economic Growth and Regulatory Paperwork Reduction Act, the Board of Governors of the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) heard concerns from financial industry representatives about the current level exempting real estate transactions from the appraisal requirement, with some industry members complaining that it has not kept pace with price appreciation in the market.
In response, the regulators proposed a rule to move the dial up to $400,000 for commercial real estate transactions, a raise that would “significantly reduce the number of transactions that require an appraisal and will not pose a threat to the safety and soundness of financial institutions.”
Established in 1994, Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) established that all real estate-related financial transactions with a value of $250,000 or less (as well as certain real estate-secured business loans with a transaction value of $1 million or less) do not require appraisals.
The Notice of Proposed Rulemaking (NPRM) would amend Title XI to establish three separate categories: the existing $250,000 threshold for residential real estate; a bump up to $400,000 for commercial real estate transactions; and the continued $250,000 level for construction-to-permanent loans. Commercial real estate transactions for purposes of the higher threshold would be defined to include loans to consumers for the initial construction of their dwelling and transactions financing the construction of any building with 1-to-4 dwelling units, so long as the loan does not include permanent financing.
In testimony about the proposal, Chairman of the FDIC Martin J. Gruenberg noted that the existing threshold has been in place for 23 years and that the change will raise the overall percentage of commercial real estate transactions exempt from needing appraisals from 17 to 28 percent. Bankers in rural parts of the country in particular urged the regulators to increase the level due in part to a scarcity of appraisers, Gruenberg said, and the proposal “will be a meaningful reduction in regulatory burden, particularly for rural banks who would be expected to originate many of these smaller transactions.”
In lieu of an appraisal, commercial real estate transactions at $400,000 or below would receive an evaluation, according to the NPRM. Pursuant to FIRREA, the evaluation must contain sufficient information and analysis to support the financial institution’s decision to engage in the transaction but does not need to be performed by a licensed or certified appraiser in accordance with the Uniform Standards of Professional Appraisal Practice. The regulations invited comment on the potential cost and time benefits of using evaluations instead of appraisals as well as other factors related to evaluations.
The regulators said that “extensive analysis” of the industry data revealed no evidence that the change in threshold would materially increase the risk of loss on such transactions. The Federal Reserve, FDIC and OCC asked for input on the safety and soundness impact of the increased threshold as well as the proposed dollar amount of $400,000. In addition, the agencies requested comment on the effective date for the proposed rule, which would start upon publication in the Federal Register.
The regulators declined to propose any changes to the appraisal threshold for residential real estate―for now. Despite requests for an increase similar to that for commercial real estate, the agencies said three reasons compelled them to hold back.
First, the increase would have a limited impact on the burden imposed on financial institutions, the NPRM stated, as appraisals would still be required for the majority of the transactions because of other government agencies or government-sponsored enterprises. Appraisals also offer consumer protection through verification that the value of the collateral property supports the purchase price and mortgage amount, the regulators said, and a threshold increase may pose safety and soundness concerns (as demonstrated by the effects of “imprudent residential mortgage lending leading up to the 2008 financial crisis”).
However, the agencies did express an interest in comments on whether the residential real estate threshold should be raised, consistent with consumer protection, safety and soundness, and reduction of unnecessary regulatory burden.
Similarly, the NPRM declined to propose an increase to the $1 million business loan threshold at the current time but asked the industry to weigh in on the appropriateness of the current level, the average size of qualifying business loans and incidences of default compared with other commercial real estate transactions, and the percentage of total real estate lending at financial institutions that is made up of qualified business loans.
To read the Notice of Proposed Rulemaking, click here.
Why it matters
The regulators predicted that the increase from $250,000 to a $400,000 threshold for commercial real estate would improve the time and cost concerns associated with closing transactions without impacting the safety and soundness of financial institutions. Although the agencies declined to suggest a similar raise for residential real estate, they did ask for comment on the current threshold, signaling the potential for a change.