HVCRE and the 15% equity rule on bank construction loans
A bank construction loan is a “high volatility commercial real estate” exposure, and carries a 150% risk weight instead of 100%, unless it fits an exemption. For apartments, the usual exemption needs two things: the loan-to-value within the 80% supervisory limit, and borrower capital of at least 15% of the property’s appraised as-completed value, contributed before the bank funds. That is why bank term sheets ask for equity measured against value, not just cost.
The rule
The definition sits in the federal banking agencies’ capital rules (12 CFR 324.2 for the FDIC, 217.2 for the Fed, 3.2 for the OCC), as rewritten after the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act (section 214, codified at 12 U.S.C. 1831bb) and the agencies’ final rule of December 13, 2019 (84 FR 68019), effective April 1, 2020.
A loan is HVCRE if it finances acquisition, development or construction of real property to turn it into income-producing property and depends on future income, sales or refinancing to be repaid. It is not HVCRE if it finances:
- one- to four-family residential properties;
- property that would qualify as a community development investment;
- agricultural land;
- existing income-producing property whose cash flow covers its debt service and expenses; or
- a commercial project where the loan-to-value is within the supervisory limit and the borrower has contributed at least 15% of the as-completed value, before the bank advances funds.
What counts as the 15%
Cash, unencumbered readily marketable assets, development expenses paid out of pocket, or contributed land or improvements. The capital has to be contributed before the loan funds, apart from a nominal advance to secure the bank’s lien.
A worked example
A project costs $48 million and appraises at $58 million as completed. 15% of $58 million is $8.7 million of capital. Assuming all of it counts as qualifying capital, that leaves room for a loan of up to $39.3 million on cost. The 80% supervisory limit on value would allow $46.4 million, so the equity test binds first. A bank lending $39.3 million would be lending 82% of cost; banks also apply their own loan-to-cost limits.
The supervisory limits
| Loan category | Supervisory LTV limit |
|---|---|
| Raw land | 65% |
| Land development | 75% |
| Commercial, multifamily and other nonresidential construction | 80% |
| 1-4 family residential construction | 85% |
| Improved property | 85% |
Source: 12 CFR Part 365, Appendix A (FDIC); 12 CFR Part 34, Appendix A (OCC); 12 CFR Part 208, Appendix C (Fed). Loans above the limits are allowed in limited amounts, tracked against the bank’s capital.
Banks, funds and HUD
Non-bank lenders aren’t bound by HVCRE, which is part of why debt funds can lend deeper. HUD’s 221(d)(4) isn’t a bank loan either; it lends up to 87% of cost on market-rate deals. The sizer puts all three side by side.