When to Apply the Real Estate Secured Business Loan Exemption

business loan

When it comes to real estate business loans, did you know that certain transactions are exempt from appraisals?

Much like the general appraisal threshold exemption, the real estate secured business loan exemption requires a focus on transaction value. While the general appraisal threshold is currently set at $250,000, the applicable threshold for real-estate secured business loans is set at $1 million.

What Constitutes a Business Loan?

Before diving into specifics, we first need to understand what exactly constitutes a business loan. For that, we turn to Appendix D in the Interagency Appraisal and Evaluation Guidelines, which states that a business loan:

“As defined in the Agencies’ appraisal regulations, [a business loan is] a loan or extension of credit to any corporation, general or limited partnership, business trust, joint venture, syndicate, sole proprietorship, or other business entity. A business loan includes extensions to entities engaged in agricultural operations, which is consistent with the Agencies’ real estate lending guidelines definition of an improved property loan that includes loans secured by farmland, timberland, and ranchland committed to ongoing management and agricultural production.”

In other words, a business loan is a loan intended strictly for business purposes.

Applying the Real Estate Secured Business Loan Exemption

Unlike the general appraisal threshold, the business loan exemption requires additional analysis — even if you determine that the transaction value is equal to or falls below the current $1 million threshold. There is an additional requirement: The primary source of repayment must not be dependent on the sale of, or rental income derived from, real estate.

Specifically, in applying this exemption the Agencies expect the bank to determine that the primary source of repayment is “operating cash flow from the business” rather than “rental income or sale of real estate.”  One important caveat to note? A bank should avoid attempts to apply this exemption even if the real property providing the cash flow upon which repayment depends is not the same real property in which the bank took a security interest.

For example, let’s look at a loan that is secured by real estate for one project in which the bank takes a security interest. The loan will be repaid from real estate sales or rental income from other real estate projects, in which the bank doesn’t have a security interest. Does that work for purposes of qualifying for the exemption? The answer is no.

Important Things to Note

There are two important things to note when considering the real estate secured business loan exemption. First, if you are a credit union regulated by the NCUA, this information does not apply. Footnote 42 of the revised Interagency Appraisal and Evaluation Guidelines states that the NCUA does not recognize an exemption from the appraisal requirements specific to member business loans.

Second, the $1 million business loan threshold may change. Although the CFPB wouldn’t be directly involved — as they would be in the general appraisal threshold given amendments to FIRREA implemented by Dodd-Frank — the business loan threshold was addressed in the same January 2012 GAO report to Congress. The GAO noted that it was more difficult to obtain relevant data, but noted that the volume of business loans under $1 million is “substantial,” citing a Federal Reserve Bank of Richmond analysis that showed $372 billion in small business loans secured by commercial real estate were made in 2009.  That said, they weren’t able to determine what percentage of those actually met the primary-source-of-repayment component to the business loan appraisal exemption.

Responses from stakeholders on whether the business loan threshold should be revised fell into the same two camps as the general threshold: those that thought it should stay the same and those that thought it should be lowered. No one recommended that it should be increased.

Have additional questions about the real estate secured business loan exemption and how it applies to the loan process or the commercial real estate appraisal process at your financial institution? Get in touch with one of our appraisal experts to learn more about appraisal exemptions and how they apply to your bank or credit union.