September 21, 2020
Doctors who are planning to construct a new medical facility have historically been a sought-after demographic for banks. Physician groups have been able to develop new projects with little to no cash equity required, by arranging high Loan-to-Value (LTV) financing, or by using equity in the land, or in another practice location, as equity and additional collateral. The Return on Investment (ROI) on a medical office building constructed with no cash out of pocket is infinite; who doesn’t love that?
Physicians need to be aware of a new acronym in commercial lending which makes it more difficult to develop a new project with little or no cash. HVCRE stands for “High Volatility Commercial Real Estate” and is a category of loans identified by Basel III Federal banking regulation (January, 2015). This appellation applies to certain acquisition and development commercial real estate loans. No matter how wonderful your new project may be, you can expect more pushback from your bank on new loans which falls into the HVCRE category.
So what makes a construction real estate loan HVCRE? The most common triggers are:
- Loan amount of > 80% LTV for a medical office building or 75% LTV for a surgery center,
- Cash equity of < 15% of the “appraised as completed” value put into the project prior to the bank loan,
Federal regulators, in their wisdom, are using banking policy to urge banks to require more cash on these “riskier” new construction projects. But this ignores the fact that physician-owned real estate often has robust cash flows, strong guarantors, and long term leases, limiting the risk to the bank.
Let’s define “equity.” Historically banks allowed equity to be contributed as cash, but also non-cash sources like appreciated land value, equity in another property added to the collateral, “sweat equity” from developers waiving their fees, and things like grants from municipalities, or state or federal agencies (TIFF funds, for example). Under HVCRE, equity now means cash, or cash used to purchase land (but only the cost of the land, not any appreciation since purchase).
Why are banks dis-incentivized to make HVCRE loans?
- Banks must reserve 50% more capital for these loans,
- Federal auditors scrutinize these loans more carefully.
Like many other regulations, each bank interprets HVCRE rules differently, and establishes various policies to categorize, limit and often charge more for HVCRE loans. Many bankers are unsure of how to interpret and enforce the policies. Some bankers seem well versed on the regulation and others seem completely unaware. Some banks increase their rates to cover the higher reserves needed, whereas others do not. But for doctors planning a new construction project, it is important to have a general understanding of HVCRE regulations.