This type of loan is sometimes abbreviated, HVCRE loan.
High volatility commercial real estate loans (HVCRE's) are credit facilities (a fancy name for loans) primarily used to finance or refinance the acquisition, development, or construction of properties. They are typically employed to fund projects that aim to turn properties into income-producing assets, relying on future income, sales, or refinancing for repayment.
These loans do not include financing for one-to-four-family residential properties, community development projects, agricultural land, or existing income-producing properties secured by permanent financing. Additionally, they exclude real estate loans made before January 2015.
My family owns a little retail property in a very nice part of Los Altos. This single tenant building has been leased to just three different tenants over the past 30 years - three successive beauty salons. If you want to get your hair done in the posh town of Los Altos, you just go to this location. There has always been a hair salon there.
Secured by this cute little retail building is a very small commercial permanent loan that is less than 15% loan-to-value.
Now I ask you? Which loan is riskier, a bridge loan to convert a failed office building into an apartment building or this little permanent loan on a standing property that has been leased every day for the last 30 years?
Obviously, the bridge loan is much riskier. The bank financing the conversion has construction risk - the risk that some unexpected governmental rule or regulation will delay the project or perhaps even stop the conversion altogether.
Then there is the construction risk of cost overruns and labor problems. Many real estate developers have been driven into bankruptcy by labor slowdowns or labor shutdowns.
Then the bank financing the conversion has leasing risk - the risk that the new apartment units will not rent for as much money as the developer projected.
If the developer was hoping to get $2,000 per month in rent, but he can only find tenants willing to pay $1,400 - well, the whole project blows up. The developer won't be able to get permanent financing in an amount large enough to pay off the bank's construction loan.
Then there is market risk - the risk that the apartment project, once the conversion is complete, won't sell for enough to pay off the bank.
This hypothetical bridge loan is an example of a high volatility commercial real estate loan. They are clearly more risky than permanent loans on standing commercial properties - projects that are completed and leased.
Federal banking regulators keep a close eye on the number of high volatility commercial real estate loans made by banks. If a bank has too many HVCRE's, the bank could blow up when the next great recession hits, say in October, when most of them hit.
How about you? Have you taken some stock market profits and bought some junky little commercial trust deeds? Historically - but no guarantees implied - they have been a fine place to ride out great recessions.
