Credit Risk Analysis of Real Estate Development Lending

From Open Risk Manual

Definition

Credit Risk Analysis of Real Estate Development Lending denotes Credit Risk Analysis of Lending products that aim to develop Real Estate (it is thus not financing existing real estate)

EBA Requirements

When assessing the creditworthiness of the borrowers in cases of lending for real estate development, in addition to the general provisions on the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should apply the specific provisions of this section[1].

The creditworthiness assessment should cover, in line with the life cycle of the loan, both the development phase, including its stages, when relevant, and the phase after the completion of the development, when the project converts into a CRE loan. The latter stage should be assessed as CRE lending, in accordance with the provisions of these guidelines.

In the assessment of the development phase, institutions should establish that the borrower:

  • has a plausible Business Plan, including a rationale for the development and a projection of all costs associated with the development verified by an independent expert;
  • has access to builders, architects, engineers and contractors for the development of the real estate;
  • has obtained or is able to obtain in the future all necessary permits and certificates for the development, as the project progresses and before disbursement(s).


Institutions should ensure that the calculation of costs associated with the development include contingencies for cost overruns. Planned contingencies should be included in the credit limit or equity. Institutions should assess the level of cash reserves and liquidity profile of the borrower to ensure that the borrower has the capacity to fund unplanned contingencies for cost overruns and delays, if any, above the contingency sum.

Institutions should perform an assessment of the feasibility of any projected net sale proceed projection, in terms of both value and volume of sales and timelines.

Institutions should carry out on-site visits, where relevant accompanied by a suitably qualified person, to verify the main components of the site, including access and site specificities, and retain a summary of the site visit in the file on the borrower.

In addition to assessing the creditworthiness of the borrower, institutions, when relevant (e.g. in cases of margin calls), should assess equity investors in the project, focusing on assessing their financial position, relevant expertise and experiences in similar projects, as well as the alignment of interests between the equity investors and the institutions offering lending to the same project.

See Also

References

  1. EBA, Guidelines on loan origination and monitoring EBA/GL/2020/06

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