View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Federal Reserve Bank of Dallas
2200 N. PEARL ST.
DALLAS, TX 75201-2272

September 15, 2005

Notice 05-49

TO: The Chief Executive Officer of each financial
institution and bank holding company in the
Eleventh Federal Reserve District

SUBJECT
Interagency FAQs on Residential Tract Development Lending
DETAILS
The Federal Reserve and the other federal financial institutions regulatory agencies have
jointly issued a list of Frequently Asked Questions (FAQs) to assist regulated institutions in
complying with their appraisal regulations and real estate lending requirements when financing
residential construction in a tract development.
ATTACHMENTS
A copy of the Board’s SR letter 05-14 dated September 8, 2005, and the agencies’ list of
FAQs are attached.
MORE INFORMATION
For more information, please contact Gary Krumm, Banking Supervision Department,
(214) 922-6218. Previous Federal Reserve Bank notices are available on our web site at
www.dallasfed.org/banking/notices/index.html or by contacting the Public Affairs Department
at (214) 922-5254.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012;
Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

BOARD OF GOVERNORS
OF THE

FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551

DIVISION OF BANKING
SUPERVISION AND
REGULATION

SR 05-14
September 8, 2005
TO THE OFFICER IN CHARGE OF SUPERVISION AND
APPROPRIATE SUPERVISORY STAFF AT EACH FEDERAL
RESERVE BANK AND BANKING ORGANIZATIONS
SUPERVISED BY THE FEDERAL RESERVE
SUBJECT: Interagency FAQs on Residential Tract Development Lending
The Federal Reserve and the other federal financial institutions regulatory
agencies are jointly issuing the attached Frequently Asked Questions (FAQ) to assist
regulated institutions in complying with the agencies' appraisal regulations and real estate
lending requirements when financing residential construction in a tract development.1 The
FAQ topics include
Definition of residential tract development, including clarification on a
residential unit and pre-sold unit
Appraisal requirements for residential tract development, raw land,
residential lots, and condominium buildings
Clarification on loan amount and collateral value for purposes of
calculating the loan-to-value ratio for residential tract development loans
Acceptable use of an appraisal of a model home
Underwriting characteristics of a revolving line of credit in which a
borrowing base sets the availability of funds to the borrower
Appraisal requirements for transactions financing the construction of
single-family homes in a residential tract development
Reserve Banks are asked to provide a copy of this letter and the FAQs to state
member banks and bank holding companies and to appropriate supervision staff. Questions
concerning this guidance should be directed to Ms. Virginia Gibbs, Senior Supervisory
Financial Analyst, at 202-452-2521.
Stephen M. Hoffman, Jr.
Deputy Director
1 of 2

Attachment:

Frequently Asked Questions on Residential Tract Development
Lending
Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
National Credit Union Administration
Office of the Comptroller of the Currency
Office of Thrift Supervision

Notes:
1. Real estate appraisal regulations: 12 CFR 208 subpart E and 12 CFR 225
subpart G. Interagency Appraisal and Evaluation Guidelines: SR letter 94-55. Real
estate lending standards regulation and guidelines: 12 CFR 208 subpart E and
appendix C.

Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
National Credit Union Administration
Office of the Comptroller of the Currency
Office of Thrift Supervision
Frequently Asked Questions on Residential Tract Development Lending
(September 8, 2005)
Purpose
The Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance
Corporation (FDIC), the National Credit Union Administration (NCUA), the Office of the
Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) (the agencies)
are jointly issuing the attached frequently asked questions (FAQs) to assist institutions in
complying with the agencies’ appraisal and real estate lending requirements for residential tract
developments. A residential tract development is a project of five or more units that are
constructed as a single development.
Overview
Institutions employ a variety of credit structures for financing a residential tract development.
When the agencies adopted their appraisal and real estate lending regulations in the early 1990s,
it was common practice for institutions to provide a developer with a credit facility to fund an
entire tract development project or subdivision. More recently, institutions tend to finance land
acquisition and development separately from home construction and limit the number of
speculative homes under construction at any one time. These trends help institutions to better
identify, manage, and control risk to a particular borrower.
Recognizing changes in lending practices, the attached FAQs provide clarification on the
agencies’ appraisal and real estate lending requirements for financing residential construction in
a tract development. The FAQs address how institutions determine collateral value and calculate
the loan-to-value ratio for these credits. Institutions should review these FAQs in conjunction
with the agencies’ real estate appraisal and lending regulations and guidelines, including the
Interagency Guidelines for Real Estate Lending Policies (lending guidelines) 1 and the
Interagency Appraisal and Evaluation Guidelines (appraisal and evaluation guidelines). 2
1

OCC: 12 CFR 34, C and D; FRB: 12 CFR 208, E and appendix C, and 12 CFR 225, G; FDIC: 12 CFR 323 and 12 CFR 365;
and OTS: 12 CFR 564, and 12 CFR 560.100, and 12 CFR 560.101. NCUA was not a party to the lending guidelines; however,
these guidelines, to the extent they are consistent with NCUA Rules and Regulations, establish best practices that credit unions
should follow.

2

The appraisal and evaluation guidelines may be found in: Comptroller’s Handbook for Commercial Real Estate and
Construction Lending for OCC; SR letter 94-55 for FRB; FIL-74-94 for FDIC; and Thrift Bulletin 55a for OTS. NCUA was not
a party to the appraisal and evaluation guidelines; however, these guidelines, to the extent they are consistent with NCUA Rules
and Regulations, establish best practices that credit unions should follow.

Frequently Asked Questions
Residential Tract Development Lending
(September 8, 2005)
1.

What is a residential tract development?
Answer: The agencies’ appraisal regulations define a “tract development” as a project with
five or more units that is constructed or is to be constructed as a single development. For
purposes of this document, a “unit” refers to: a residential building lot; a detached singlefamily home; an attached single-family home; or a residence in a condominium building.

2.

What are the appraisal requirements when an institution finances residential tract
developments?
Answer: An appraisal for a residential tract development must meet the minimum appraisal
standards in the agencies’ appraisal regulations and guidelines. Appraisals for these
properties must reflect deductions and discounts for holding costs, marketing costs, and
entrepreneurial profit. In some circumstances, as discussed in FAQ 11, an institution may
rely on an appraisal of the individual unit(s) to meet the agencies’ appraisal requirements
and to determine market value for calculating the loan-to-value (LTV) ratio.
An institution may exclude presold units to determine whether an appraisal of a tract
development is required. A unit may be considered pre-sold if a buyer has entered into a
binding contract to purchase the unit and has made a substantial and nonrefundable earnest
money deposit. Further, the institution should obtain sufficient documentation that the
buyer has entered into a legally binding sales contract and has obtained a written prequalification or commitment for permanent financing.

3.

What are the appraisal requirements when an institution finances raw land, lot
development or lot acquisition as part of a residential tract development?
Answer: The institution must obtain an appraisal, which includes appropriate deductions
and discounts, of the entire tract of raw land or lots. The appraisal should reflect the value
of the property in its current condition and existing zoning as well as the market value of
land upon completion of land improvements, if applicable. The land improvements may
include the construction of utilities, streets, and other infrastructure necessary for future
development. An appraisal of raw land to be valued as developed lots should reflect a
reasonable time frame during which development will occur. The feasibility study or the
market analysis in the appraisal should support the absorption period for the developed lots;
otherwise, a portion of the tract development should be valued as raw land.

2

4.

What are the supervisory LTV limits for residential tract developments?
Answer: An institution may lend up to 65 percent of the value for raw land, 75 percent for
land development or finished lots, 80 percent for multifamily residential construction, and
85 percent for 1- to 4-family residential construction. 3 If a loan funds both land
development and home construction, the applicable supervisory LTV limit is 85 percent,
which corresponds to the limit for the final phase of the project. However, loan
disbursements should not exceed actual development or construction costs, and the
institution should ensure that the borrower maintains appropriate levels of hard equity
throughout the term of the loan.

5.

When should institutions calculate the LTV ratio for residential tract development
loans?
Answer: An institution should calculate the LTV ratio at the time of loan origination and
re-calculate the ratio whenever collateral is released or substituted. If the LTV ratio is in
excess of the supervisory LTV limits, the institution should comply with the lending
guidelines for high LTV loans.

6.

What is the loan amount to be used to calculate the LTV ratio for residential tract
development loans?
Answer: As defined in the lending guidelines, the loan amount refers to the total amount of
a loan, line of credit, or other legally binding commitment. For a line of credit, the legally
binding commitment is based on the terms of the credit agreement.

7.

How should institutions determine the loan amount to calculate the LTV ratio for a
loan to finance a phase of a multi-phase tract development?
Answer: If an institution commits to finance only a phase of development or construction
rather than an entire multi-phase tract development project, the loan amount is the legally
binding commitment for the phase.

8.

What collateral value is used to calculate an LTV ratio for a residential tract
development loan?
Answer: The value of the real estate collateral for the calculation of the LTV ratio is the
“market value” as defined in the agencies’ appraisal regulations. The appraisal should
reflect a market value upon completion of construction of the home(s) and the market value
of any other collateral, such as lots or undeveloped land. Further, the appraisal must
consider an analysis of appropriate deductions and discounts for unsold units, including

3

NCUA Rules and Regulations Part 723 (Member Business Loans) has specific LTV requirements that vary from these
guidelines. Credit Union State Supervisory Authorities may also have regulatory LTV requirements that vary from these
guidelines. Credit Unions supervised by these agencies should review the LTV limits and ensure compliance.

3

holding costs, marketing costs, and entrepreneurial profit. For loans to purchase land or
existing lots, “value” means the lesser of the actual acquisition cost or the appraised market
value.
9.

How can an appraisal of a model(s) home be used to establish a market value for
calculating the LTV ratio?
Answer: An appraisal of a model(s) provides a market value of a particular home in a
given development, considering the cost of construction and the market value of the
model’s unique features and floor plan on a typical lot. Normally, an institution will obtain
an appraisal for each model or floor plan that a borrower is planning to build and offer for
sale. The model appraisal is based on the price of a “base” lot in a particular development
without consideration to the costs of, or value attributed to, specific options, upgrades, or
lot premiums.
If the institution is financing the construction of a residential tract development, an
appraisal of the model(s) would provide relevant information for the appraiser to consider
in providing a market value of the development. That is, the value attributable to the
models is used as a basis for estimating a market value for the tract development by
reflecting the mix of units and adjusting for options, upgrades, and lot premiums. The
market value should also reflect an analysis of appropriate deductions and discounts for
holding costs, marketing costs, and entrepreneurial profit.
For the construction of units that are not part of a tract development, the appraisal of a
model may be used to estimate the market value of the individual home, if the model and
base lot are substantially the same as the subject home and the appraisal meets the
agencies’ appraisal requirements and is still valid. In assessing the validity of the appraisal,
the institution should consider the passage of time and current market conditions. When
underwriting a loan to finance construction of a single home, the institution should consider
the value of the actual lot and any options and upgrades relative to the values in the
appraisal of the model.

10.

What are some common underwriting characteristics of revolving lines of credit in
which a borrowing base sets the availability of funds?
Answer: A borrowing base is a lending condition incorporated into many revolving credit
agreements that limits the institution’s legally binding commitment to advance funds to the
borrower. The borrowing base specifies the maximum amount the institution will lend to
the borrower as a function of the collateral’s type, value, eligibility criteria, and advance
rates. The credit agreement also specifies a maximum commitment amount regardless of
the amount of the borrowing base availability.
Typically, the borrowing base formula specifies different advance rates for each collateral
type, such as land, developed lots, homes under construction, and completed and unsold
homes. The amount of collateral in each category and the corresponding advance rates
limit the borrower’s ability to draw additional funds. The advance rates are generally

4

higher for collateral with lower development, construction, and marketing risk. For
example, the advance rate for developed lots is likely to be lower than that for a completed
home. In addition, advance rates may vary among borrower credit agreements. Generally,
institutions grant more liberal advance rates to borrowers that have greater financial
strength. Collateral must meet specified eligibility criteria to be included in the borrowing
base. These commonly include limitations on the number of speculative units and the
duration of time a completed unit may remain in the borrowing base.
This type of facility enables an institution to control loan advances and proceeds from
home sales. The funds available under the revolver are based on frequent (usually
monthly) borrower-prepared reports, commonly referred to as a borrowing base certificate.
The borrowing base certificate details and certifies the quantity and value of collateral in
each category that meets the borrowing-base eligibility criteria and a total amount of the
borrowing base (the outstanding balance of the facility plus any available funds). The
institution periodically performs on-site verification of the information provided by the
borrower.
When constructing the borrowing base formula, the institution should require the borrower
to maintain appropriate levels of hard equity throughout the project’s construction and
marketing periods.
11.

Are there instances when an appraisal that reflects deductions and discounts is not
necessary for financing construction of single-family homes in a residential tract
development?
Answer: An appraisal of a tract development must analyze and report appropriate
deductions and discounts. However, there are circumstances when the structure of the
proposed loan mitigates the need to obtain an appraisal of a tract development.
If an institution finances construction starts on an individual unit basis, an institution may
be able to use appraisals of the individual units to satisfy the agencies’ appraisal
requirements and as a basis for computing the LTV ratio. In this case, the institution
should be able to demonstrate, through a feasibility study or market analysis conducted
independently of the borrower and loan production staff, that all units collateralizing the
loan are likely to be constructed and sold within 12 months. For LTV purposes, the value
is the lower of the market value of the collateral or the borrower’s actual development and
construction costs. The borrower should maintain appropriate levels of hard equity (for
example, cash or unencumbered investment in the underlying property) throughout the
construction and marketing periods.
If an institution finances a unit’s construction under a revolving line of credit in which a
borrowing base sets the availability of funds, an institution may be able to use appraisals on
the individual units to satisfy the agencies’ appraisal requirements and as a basis for
computing the LTV ratio. This is the case if the institution limits the number of
construction starts and completed, unsold homes included in the borrowing base and if the
institution satisfies the conditions described in the preceding paragraph. If the borrowing

5

base includes developed lots or raw land to be developed into lots, the institution must
obtain an appraisal of the collateral that reflects deductions and discounts.
Institutions should also ensure that residential construction loans meet prudent real estate
underwriting standards reflected in the lending guidelines. Among other standards,
institutions should (a) establish appropriate limits on construction starts for speculative
homes; (b) address any concentration risk to a particular builder or a specific development;
(c) monitor market conditions and analyze demand and supply for residential housing;
(d) maintain prudent controls for the advancement of funds for construction costs;
(e) perform periodic collateral inspections to verify construction progress; and (f) confirm
compliance with supervisory LTV limits.
12.

What are the appraisal requirements when an institution finances construction of a
condominium building(s)?
Answer: For a condominium building with five or more units, an institution must obtain an
appraisal of the building that reflects appropriate deductions and discounts for holding
costs, marketing costs, and entrepreneurial profit. An institution may not use the aggregate
retail sales prices of the individual units as the market value to calculate the LTV ratio. For
purposes of this document, condominium buildings are distinguished from other types of
residential properties if construction of the entire building has to be completed before any
one unit is occupied.
If an institution finances the construction of a single condominium building with less than
five units or a condominium project with multiple buildings (e.g., clustered condominiums
and town homes) with less than five units in a building, the institution may be able to rely
on appraisals of the individual units to satisfy the agencies’ appraisal requirements and to
determine the market value for calculating the LTV ratio. In this regard, the institution
should be able to control starts on an individual building basis and demonstrate by a
feasibility or market analysis, conducted independently of the borrower and loan
production staff, that all units in each building can be constructed and sold within
12 months.

13.

For revolving lines of credit in which a borrowing base sets the availability of funds,
what loan amount and collateral value should be used to determine the LTV ratio?
Answer: The loan amount is the institution’s legally binding commitment (that is, the
outstanding balance of the facility plus any availability under the borrowing base). Value is
the lower of the borrower’s actual development or construction costs or the market value of
completed units securing the loan multiplied by their percentage of completion.

6


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102