Observations on Permissible Real Estate Investments for Banks and Their Holding Companies   

by Charles D. Gullickson

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Banks and bank holding companies are creatures of limited powers. State and federal law place significant constraints on permissible activities and permissible investments for banks and BHCs.

For banks in South Dakota all of the action when it comes to these constraints is at the federal level, for both state and national banks. All of the applicable limitations under federal law apply to both state banks and national banks (and their BHCs), and nothing under South Dakota law imposes limitations on South Dakota banks that is not also imposed by federal law. For state banks the key limiting statutory provision is 12 U.S.C. §1831a which in essence provides that a state bank may not engage in any activity or hold any investment that is not permissible for national banks, unless the state bank receives the prior approval of the FDIC.

Here are highlights that apply to investing in or owning real estate:

  • Banks and their subsidiaries obviously can lease or hold real estate for their own banking-related activities, and BHCs can lease or own real estate for banking-related activities conducted by their subsidiary banks.
  • Banks obviously can also own “other real estate owned” (OREO) – real property acquired as a result of a foreclosure or otherwise acquired in connection with a borrower’s obligations owed to the Bank. Regulators expect, however, that OREO will be owned by a bank for a limited period of time while it attempts to dispose of the property. The Federal Reserve Board, too, has limitations on how long a holding company can own OREO on behalf of its subsidiaries’ banking-related activities.
  • Banks and BHCs also have the authority to acquire real estate for expected future use of the property for the organization’s banking-related activities. The rules get hazy, however, when a banking organization intends to “warehouse” property for a period of time before ultimately developing it for future use. Banking organizations cannot speculate in real estate, and the acquisition of real estate for expected future use must be based on a credible plan to use the property for permissible purposes in the reasonable future, with “reasonable” being in the eye of the beholder. The OCC has guidance on this issue that would also be applicable to state banks as a result of 12 U.S.C. §1831a. The Federal Reserve does not have formal guidance for BHCs on how long they may hold real estate for anticipated future use by their banking subsidiaries, but there is an expectation that the property will be put to use for banking purposes within a “plannable” future, and in the author’s experience a “plannable” future is probably two or three years, perhaps five as an outside limit.
  • Under certain circumstances banking organizations may also own real estate for community development purposes, but the rules get tricky here. Generally, a real estate investment for community development purposes must be tied to development of low- to moderate-income areas or the creation of economic activity for the benefit of low- to moderate-income persons.

Two key themes run through these limitations. First, banking organizations may not speculate in real estate, and real estate investments made simply for the expectation of future gain in the value of the investment are not permitted. Second, the acquisition and retention of real estate must have a purpose related to the organization’s banking-related activities – owning real estate simply for the enjoyment or use of bank management or ownership doesn’t make the grade.

Finally, real estate investments made for the purpose of community development need to be treated with caution. No matter how civic-minded the bank may be, real estate investments made with the intent to better the bank’s community must almost always have some connection with improving low- to moderate-income areas or the lives of low- to moderate-income people.

Davenport, Evans, Hurwitz & Smith, LLP, located in Sioux Falls, South Dakota, is one of the state’s largest law firms. The firm’s attorneys provide business and litigation counsel to individuals and corporate clients in a variety of practice areas. For more information about Davenport Evans, visit www.dehs.com.