Appraisal and Real Estate Lending Requirements for Residential Tract Developments

Article excerpt

Per Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), one of the five minimum appraisal standards for all federally related transactions is that all appraisals must "analyze and report appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units." In September 2005, the five federal agencies jointly issued Frequently Asked Questions on Residential Tract Development Lending (FAQs) to assist financial institutions in complying with the agencies' appraisal and real estate lending requirements for residential tract developments. The FAQs provide much needed clarification on this topic, but do not result in any new regulatory requirements. Specifically, the FAQs address how institutions should determine collateral value and calculate loan-to-value (LTV) for loans secured by tract development. This article looks at the FAQs from a bank reviewer's perspective.

For many years, the appraisal of residential tract developments has been a source of consternation for appraisers and lenders alike. Prior to FIRREA, many development and construction loans were underwritten on the basis of aggregate retail prices, and this, in part, is what precipitated the minimum appraisal standards promulgated in FIRREA. Even today, however, many banks are still reportedly underwriting on this basis, or they are uncertain as to what "value" is required. Frequently Asked Questions on Residential Tract Development Lending was jointly released by the agencies in September 2005 to help provide guidance. The newly published document does much to address many questions posed by lenders and appraisers with regard to development properties, but it also raises other issues to be addressed.


The FAQs apply to residential raw land, finished lots, and vertical construction where five or more units are constructed as a single development. Within this document, several key terms are defined.

* Tract development--A project of five or more units that is constructed or is to be constructed as a single development (per FAQ #1).

* Unit--A residential building lot; a detached single-family home; an attached single-family home; or a residence in a condominium building (per FAQ #1).

* Loan amount--The total amount of a loan, line of credit, or other legally binding commitment. For a line of credit, the legally binding commitment is based on the terms of the credit agreement (per FAQ #6).

* Pre-sold--A unit in which a buyer has entered into a binding contract and has made a substantial and nonrefundable earnest money deposit (per FAQ #2).

With regard to value, several definitions are discussed.

* For the calculation of LTV, value is the "market value" as defined in the agencies' appraisal regulations. The appraisal should reflect a market value upon completion of construction of the home(s) and the market value of any other collateral, such as lots or undeveloped land. Further, the appraisal must consider an analysis of appropriate deductions and discounts for unsold units, including holding costs, marketing costs, and entrepreneurial profit (per FAQ #8).

* For loans to purchase land or existing lots, value is the lesser of the actual acquisition cost or the appraised market value (per FAQ #8).

* For revolving lines of credit in which a borrowing base sets the availability of funds, value is the lower of the borrower's actual development or construction costs or the market value of completed units securing the loan multiplied by their percentage of completion (per FAQ #13).

Credit Structures

In the FAQs Overview, it is acknowledged that institutions employ a variety of credit structures for the financing of residential tract development. In the early 1990s, it was common practice for banks to provide funds to a developer for an entire tract development project or subdivision, and it was common practice to order an appraisal of the entire tract. …