Banks Are Entitled to Equity Positions in the Real Estate Projects They Finance

By Thomas, Eugene L. | American Banker, May 7, 1984 | Go to article overview

Banks Are Entitled to Equity Positions in the Real Estate Projects They Finance


Thomas, Eugene L., American Banker


Commercial banks are currently one of the major participants in the real estate finance market. They support all phases of real estate lending from short-term construction financing to long-term mortgage lending. In fact, one out of every five residential mortgage loans are made by banks.

Expanding commercial banks' power to make equity investments in real estate, however, will enable banks to take additional advantage of their real estate expertise in ways that result in additional benefits to the real estate market and to the public.

Banks are currently prevented from making equity investments in real estate by a "sin of omission." The Bank Holding Company Act lists permissible activities "closely related to banking" in which subsidiaries may engage, but equity investments are excluded.

Changes in the market have demonstrated the need for expanding banks' powers in the real estate area. The interest rate shocks, price shocks, and oil shocks since the early 1970s would have been ruinous to the real estate industry but for the flexibility of borrowers and lenders to develop new and creative approaches to real estate finance, such as adjustable rate mortgages. So long as market conditions remain unpredictable, continued and greater flexibility is needed by all market participants.

In addition, without the ability to make real estate equity investments, commercial banks are operating at a competitive disadvantage. Tehy are prevented from meeting customer needs while other competitors such as savings and loans and life insurance companies are not.

I have had to personally turn away developers and contractors that wanted the bank to become a s trong financial partner. When these long-time customers left, they turned to my S&L competitors. All the Risk, No Profit

To be able to maintain or improve customer relationships and to develop new ones, my bank, and all banks, must have the authority to make equity investment in real estate. If not, we're disadvantaged.

At present, many bankers feel that they take all the risk inherent in the development of a real estate project while the borrower reaps all the profit, if any. The equity powers would be used to allow the lender to share in some way the profits of the venture. This has long been a common practice of the life insurance industry. Banks would like the same chance.

The opportunities for banks in real estate investment have been assessed in a major Arthur Young & Co. study. This research weighed the feasibility and profitability of bank entry into selected service markets from which they were formerly or are currently prohibited.

The study concluded that real estate equity would be attractive to all banks regardless of size. Banks have an existing customer base from which to draw, and banks with real estate departments already have personnel with expertise in property appraisal, real estate markets, management of real estate, real estate financing arrangements, and credit appraisal. In my department, the officers "eat, sleep, and drink" all facets of real estate each and every day. Closely Related

Thus, according to the Young study, banks are well positioned to enter into real estate joint ventures by taking equity participations in the projects they finance, and this activity is closely related to other services offered by commercial banks.

Despite these findings, attempts to expand bank powers in this area have met with little success. …

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Banks Are Entitled to Equity Positions in the Real Estate Projects They Finance
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