The impact of the New Basel Capital Accord on real estate developers

Abstract

PurposeThe New Basel Capital Accord (Basel II) was published in June 2004. This modification of the regulatory framework for banking institutions raises the question to what extent real estate financing will be impacted and how market participants can be adequately prepared. Aims to examine the impact of Basel II on the future pricing and availability of debt capital and on the cost of capital in real estate financing and to present possible reactions for real estate developers.Design/methodology/approachThis research paper follows a deductive approach. First, the New Basel Capital Accord and the main features of commercial real estate financing are presented. On a normative level, the implications for developers are explained. Since no information regarding the behaviour of market participants in commercial real estate financing was available, the authors have ascertained the relevant questions within the framework of an empirical analysis. A total of 205 banking institutions were asked to fill out a survey pertaining to commercial real estate financing. The results of this survey are partly presented and interpreted.FindingsThe availability and the pricing of debt capital will be risk‐adjusted and will depend on the amount of regulatory equity banks will have to hold in reserve for a credit engagement. The cost of debt capital in real estate financing will rise due to systemic reasons of the New Basel Capital Accord. Banks are/will be very restrictive with regard to credit allowances. The use of the positive leverage effect will become more difficult. Structured financing, particularly the use of private equity, is the best way to fill a potential financing gap.Originality/valueThe paper is a timely investigation of a significant regulatory framework that is of world‐wide significance. The New Basel Capital Accord is introduced in its fundamental structure and the two relevant rating approaches are described and put into context. The paper reduces the complexity of the comprehensive and sophisticated Basel Capital Accord. Based on the facts that have been analysed, recommendations of how real estate developers can react to the changes in financing that lie ahead are given.