No matter how savvy and experienced, lenders and other clients who provide commercial real estate financing often seem to get tied in knots when considering the mortgage financing of a ground lease or other leasehold interest. Key considerations may be overlooked in the process of analyzing and underwriting a potential credit. I often provide the list of points below to clients to consider when reviewing a leasehold financing opportunity. While the list is by no means all inclusive and situations may vary greatly, it is a great starting point and a checklist that can be useful in assuring that vital issues are not overlooked.
1. A different kind of mortgage. Merely adding the word “leasehold” to your standard mortgage does not create a leasehold mortgage that is effective to protect the lender’s interests. Special covenants and remedies are necessary to preserve the lease – the collateral – and the lender’s rights.
2. Study the lease. Scrutinize the underlying lease - often it is a ground lease.
Does it:
•Allow the tenant to grant a leasehold mortgage?
•Have a term longer than the loan?
•If not, have extension options the lender may utilize?•Have purchase options the lender may utilize?•Have predictable rent?
3. Check the landlord’s title. Examine the title to the fee estate (landlord/owner) and not just the leasehold estate (tenant/mortgagor). Insure the leasehold mortgage. Assure the lease or a memorandum of lease has been recorded. Obtain estoppel certificate from the landlord that is suitable for the situation.
4. Address the landlord’s liens. If the landlord’s/owner’s interest is subject to a mortgage, obtain a non-disturbance agreement which specifically addresses the leasehold mortgage situation.
5. Negotiate right to cure. The lease cannot be permitted to “disappear”! The lender must be able (under the lease or with the landlord’s agreement) to:
•Receive notice of the tenant/borrower’s default
•Cure a tenant default and receive extra time to do so
•Obtain possession of the premises to cure
•Receive a waiver of non-curable defaults (or a new lease).
Many ground leases are drafted with the interests of a subsequent leasehold mortgagee in mind and afford suitable rights to the lender, but if the lease does not contemplate or fully address a leasehold mortgage, then a modification or a separate recorded agreement will be necessary to address the concerns noted here, as well as in items
6, 8 and 9.6. Consider bankruptcy impact. The potential responses to a bankruptcy filing by the tenant/borrower and by the landlord must be addressed - in the leasehold mortgage, including assumption or rejection of the lease.
7. What is the lease worth?
In addition to the term and options, consider whether restrictive use provisions in the lease will diminish your collateral value (the lease) if you are forced to address a loan default. Are there restrictions on “going dark”?
8. Special remedies. A leasehold mortgage can be enforced through foreclosure…but consider additional remedies: the granting of a new lease or the assignment of the lease to a new tenant. The lease should have a “no merger” clause.
9. Lender’s rights. Address the lender’s right to enforce the lease, consent to amendments, receive insurance proceeds, and obtain possession.
10. Sublease financing?
Do you really want to take on the complexity of mortgaging a sublease?
Tim Dietrich is a partner with the law firm of Barley Snyder. He provides strategic advice for businesses, financial institutions and governments in a number of areas. tdietrich@barley.com | (610) 898-7154.