Feel Secure About Your Deal’s Collateral
Know which aspects of the property lenders will scrutinize
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Commercial mortgage brokers know lenders pay a great deal of attention to collateral securing a commercial-property
loan. Unsurprisingly, lenders are keen to take every possible step to preserve collateral’s value in the face of financial downturns that may impact the owner’s position or calamities like natural disasters, terrorist attacks or vandalism that can damage the collateral itself.
Gaining awareness of the aspects of the asset that lenders are likely to scrutinize helps commercial mortgage brokers get a leg up on providing sufficient information about the collateral to the lender and ultimately helps them close deals more efficiently. Here are six main areas to focus on:
- The condition of the collateral: Lenders think of collateral as a living body with systems that must work efficiently to preserve its value. They typically order a property-condition assessment to learn the condition of these systems and find out if any repairs are needed. If work is necessary, lenders likely will require the owner to escrow funds for repairs through the loan term.
- Title issues: Lenders typically order a title report to determine if other lenders or creditors have interests that are superior to theirs. For example, if contractors perform work on the property, lenders may require the owner to get lien releases to prohibit these liens from attaching to the collateral. If other mortgages show up on title, lenders may require owners to get satisfaction of mortgage documents.
- Insurance: Expect lenders to require owners and tenants to carry sufficient insurance to protect the collateral, and to name the lender as additional insured and certificate holder on all insurance policies.
- Subordination of leases: Lenders are likely to insist all leases become subordinate to the loan. If a lease was entered before the date the lender recorded the mortgage, the tenant will have a priority in interest unless the lease included a subordination clause. In the subordination clause, the tenant agrees that its lease will be subordinate to the lender’s lien and any renewal or modification thereof. This means the lender has the priority in interest and most flexibility in the event of a foreclosure because under this circumstance the lender may elect to, but does not have to, terminate all leases.
- A non-disturbance and attornment agreement: Many tenants with longterm leases invest significant funds to negotiate the lease and improve their space, and they will suffer financially if the lease is terminated because of the owner’s default. To ameliorate this risk, strong tenants, therefore, often request lenders to enter into a non-disclosure and attornment agreement. This agreement prevents the lender from disturbing the tenant’s possession during the term of the lease, even in case of foreclosure, as long as the tenant is in compliance with the lease. In return, the tenant agrees to attorn the lender — that is, to deal with and pay rent directly to the lender.
- Rights to control collateral, leases and income stream: To maintain control over the collateral, many lenders require owners use the lender’s standard lease form and immediately report any default. Many lenders also prohibit owners from modifying, renewing or entering into new leases without the lender’s written consent. Lenders also require tenants provide a written assignment of leases and rents. This assignment is triggered by a tenant default and enables the lender to collect rent directly from the tenant — something the lender would not be entitled to do without this document.
By learning these lender requirements, commercial mortgage brokers may avoid unpleasant surprises when dealing with issues related to collateral, and they may ensure their clients are prepared and ready to meet to the lender’s requirements in order to secure financing. Feel free to contact me Professor Real Estate® if you have any questions about property taxes, millage rates, property tax exemptions and property appeals!
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Copyright © 2012 Suzanne Hollander, Professor Real Estate® The People’s Professor.