The current U.S construction sector is at a cross roads. Banks are seeing some of the lowest loss rates of the past six years on commercial real estate and construction loans, thereby boosting the case for increased lending activity in the sector.
The net charge-offs for commercial real estate loans were 0.16% of average loan balances in the most recent quarter. This is down from 0.9% at the end of 2009 and 13 basis points below June 2013 quarter rates. Loss rates for construction and land development loans have fallen from 3.58% of average loan balances in December 2009 to 0.24% in the most recent quarter. In addition to falling loss rates, the improving economy and increased competition for attractive borrowers in the commercial and industrial lending space is also positively contributing to a sense of confidence in lending activity in this sector. Increased competition for borrowers might allow for more appealing terms or incentives, he noted.
In a recent report, the Federal Reserve found that, banks on balance have been easing standards on most types of commercial real estate. The FDIC’s latest quarterly report cements this fact, showing that banks’ commercial real estate lending has increased to levels unseen since 2007.
For several years, banks moved away from commercial real estate lending because of losses tied to real estate loans before the Great Recession. Demand, too, had been weak as contractors and investors either collapsed or backed off dramatically in the wake of real estate market woes. Recently though, this began to change. Commercial bank portfolio loans for commercial and multifamily mortgage loans have increased 19% in the second quarter from a year earlier.
Commercial real estate loans as a percentage of total loans and leases at U.S. banks have slowly increased since 2008. These loans now make up 24.68% of portfolios, compared to 19.55% as of March 2008. Construction and land development loans were 5.14% of total loans and leases in the June-ended quarter, down from 8.88% in March 2008.
Low demand for credit and fewer credit-worthy projects are now the biggest challenges for banks in making commercial real estate loans.
Risk is an important factor for banks, which are under increased regulatory scrutiny and requirements to adequately stress test their commercial real estate portfolios. Banks have been burned before and regulators want to know whether they have changed fundamentally when giving out loans! Even though confidence has come back significantly, there still exists an overhanging uncertainty of things going downhill.
A recent report by the Real Estate Research Corporation (RERC) cautioned that increased demand for commercial real estate and competition for high-quality assets will cause asset prices to overtake their property values in certain sectors, hence the relationship between the value versus price of commercial real estate is precariously balanced. Analysts believe that there is certainly a chance of an upward pressure on pricing without a corresponding increase in value, and when this happens, investors and businesses may be forced to accept lower returns for assets with added risk.
Thus, the whole commercial loans industry is at a place where things can go either way, but with positive market indicators, things are looking more up then down.
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