CREJ - Office Properties Quarterly - October 2015
The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in July 2010 and “represents the most comprehensive financial regulatory reform measures taken since the Great Depression,” according to The Dodd-Frank Act: A Cheat Sheet. This article will explore three effects the act has had on commercial real estate in Denver as they relate to the financial services sector – lending, employment and banking. Downtown Denver’s office market has seen impressive activity in recent years, and there is much to suggest these positive trends will continue. With 25.8 million square feet of existing office space and an additional 1.8 million sf of office space under construction, Denver is experiencing unprecedented growth. One of Denver’s largest active tenant bases is the financial services sector. Financial services is a dynamic industry that encompasses a range of businesses, including but not limited to banking, mortgage, credit card, insurance and investment funds. In fact, Denver’s 17th Street is considered the “Wall Street of the West,” due to the high concentration of financial services companies. As demonstrated in the first figure, between second-quarter 2014 and second-quarter 2015, financial services and institutional lender tenants accounted for 14 percent of the total space leased during this time in Denver. This is equivalent to more than 1.2 million sf and represents Denver’s largest sector for office leasing activity in the past year, according to CBRE research. Specifically in the downtown submarket, financial services and institutional lending companies occupy 25 percent of Class A and AA office space, second only to the energy sector. The financial services industry largely is impacted by government regulations and compliance. Since the passing of the Dodd-Frank Act, these regulations have increased. Proponents of the Dodd-Frank Act lauded it as “landmark legislation that will reduce the likelihood and magnitude of future financial panics, end taxpayer bailouts of Wall Street and enhance consumer protection,” according to Randall Guynn in “The Financial Panic of 2008 and Financial Regulatory Reform.”
Critics predicted that the stricter lending laws would reduce capital, stifle employment and quicken decline. Five years since the initial passing, the Dodd-Frank regulations have impacted Denver’s financial services sector regarding lending, employment and banking, each of which has implications to a company’s real estate strategy. First, the regulations implemented impacted lending by imposing capital requirements on banks involved in acquisition and development. According to The Heritage Foundation, the cornerstone of the DoddFrank Act is a lender obligation to determine that a borrower has the ability to repay the loan. This shift of accountability “presumes that consumers are incapable of acting in their own interests,” said Diane Katz in “Dodd-Frank Mortgage Rules Unleash Predatory Regulators.” Because of this, credit is much less available to borrowers, even for those with excellent credit scores. What does this mean for commercial real estate? Banks are making fewer loans, thus doing less business, which is impacting their bottom line and has ramifications for everything from hiring to office space. Second, with regard to employment, some speculated that the newly imposed regulations would have a positive impact on job creation due to increased compliance requirements. “These include costs of mandatory reporting under rules from the new Office of Financial Research and the Consumer Financial Protection Bureau; costs of creating and retaining records to meet future audit and compliance requirements; costs of legal counsel, accountants, and other experts for advice on compliance and applicability of regulations; increased costs associated with new rules for credit agency reports and securitization requirements; and many others,” said Paul Bent in “Dodd-Frank: What about Leasing?” In other words, more employees would be needed to ensure financial institutions are complying with new regulations. Critics worried that the limited lending as a result of restrictions would lead to more job losses. This is important for corporate real estate strategy because if employment was significantly declining, many organizations would be looking to reduce their square footage or move to less expensive areas. Thankfully in Denver, CBRE’s research reports the market has seen an increase in financial services employment growth since DoddFrank passed in 2010. As of June, year-over-year growth in financial services was 1.4 percent. Currently, nearly 130,000 people work in the industry and this is edging closer to the prerecession peak of more than 135,000 financial services employees. Finally, small banks with less capital to fund the cost of compliance may be particularly vulnerable to the effects of this act. The risk for small-bank failure is heightened due to costly implementation of new regulations, which also restricts new bank formation and expansion. “Almost no new community banks have been formed in the past few years,” said Bill Floersch, former CEO of ABN Amro Clearing Americas. “This is in part due to stricter requirements and reduced profit potential.” The claim that more banks failed due to the passing of Dodd-Frank is complicated because research shows that the number of banks has been steadily declining since long before the Dodd-Frank Act, according to a first-quarter 2015 FDIC report. While traditional banks have experienced a decline and this affected their demand for office space, new nontraditional lenders are filling the void and pushing the market toward surpassing prerecession levels. The doors opened by Dodd-Frank for these new lenders may be helping financial services absorb additional space and employ more people in the wake of the financial crisis. In conclusion, a review of the Dodd-Frank Act reveals both negative and positive implications for commercial real estate as it relates to the financial services industry, and it is possible that the full effect of the legislation will not be recognized for several more years.