If any doubts remain that real estate investors and single family rentals have hit the big time, check out a bulletin issued last week by the Office of the Comptroller of the Currency, the agency that regulates all federally chartered banks and thrifts.
Just to make sure that lenders get the message, the OCC served an official notice that the financing of single family rentals (which it calls Investor Owned Residential Rentals, or IORRs) is to be managed with the same risk management policies and procedures used for commercial real estate loans, not residential mortgages.
“Some banks manage IORR loans in a similar manner to owner-occupied one- to four-family residential loans. The credit risk presented by IORR lending, however, is similar to that associated with loans for income-producing commercial real estate (CRE). Because of this similarity, the Office of the Comptroller of the Currency (OCC) expects banks to use the same types of credit risk management practices for IORR lending that are used for CRE lending. This expectation does not change the regulatory capital, regulatory reporting, and Home Owners’ Loan Act (HOLA) requirements for IORR,” said the message to financial institutions.
The bulletin is a shot across the bow and fair warning to lenders and it’s probably not a coincidence that it was issued two months after the OCC was chastised by the Treasury Department’s inspector general and the GAO for failing to spot widespread problems in the foreclosure practices of major banks between 2008 and 2010. The agency’s examiners underestimated the mounting risks and were given outdated guidance that did not address how the industry had changed.
Just to be sure it avoids a similar embarrassment with single family rentals, the OCC’s missive lays down the law for benks, but, ot course, the folks who will feel the greatest impact are landlords and investors:
- Lenders are now responsible for finding out if an owner converts a property from owner-occupied to rental and properties should be segregated from other residential loans so that the bank can effectively manage the risk. Lenders. must put in place credit risk management policies and processes suitable for the risks specific to IORR lending. The primary source of repayment for an IORR loan is normally the rental income from the financed property, supported by the borrower’s other personal income. In addition, repayment sources for IORR loans may be volatile and highly leveraged in cases where the borrowers have multiple financed properties. Therefore, lenders will put new policies and processes in place to cover loan underwriting standards; loan identification and portfolio monitoring expectations; allowance for loan and lease losses(methodologies; and internal risk assessment and rating systems. Translation: owners will not be allowed to rent out a mortgaged home. They will be required to get a commercial loan on terms that will certainly be less favorable.
- Lending for single family rentals should follow the same regulations and procedures as commercial loans, including supervisory loan-to-value (LTV) limits. “IORR loan policies should establish prudent underwriting standards that are clear, measurable, and within the risk appetite approved by the board of directors.”
- Amortization for income-producing properties is 15 to 30 years. Further, loan policies should establish underwriting standards pertaining to appropriate owner equity, acceptable appraisal and/or valuation methods, insurance requirements, and ongoing collateral monitoring.
- Borrowers may finance multiple properties through one or more financial institutions but underwriting standards and the complexity of risk analysis should increase as the number of properties financed for a borrower and related parties increases. When a borrower finances multiple IORR properties, a comprehensive global cash flow analysis of the borrower is generally necessary to properly underwrite and administer the credit relationship. In such cases, bank management should analyze and administer the relationship on a consolidated basis.
The bottom line is small-time investors are going to get calls from their lenders looking for rentals that are still under mortgages. If they want to keep their financing, they’ll find that they will have to meet very different standards and ratios (and pay higher interest rates), and all investors getting bank financing may find themselves under tighter scrutiny when it comes to the size of their operations and their LTV ratios.
Welcome to the big leagues.
Photo: Brandon HuntWelcome to the Big Leagues of Borrowing by Steve Cook