S.E.C. Real Estate Observer

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Murphy’s First Rule: If it can go wrong in a real estate transaction, it will!

Keep in mind that Murphy is an optimist!

Nonrecourse Financing

You’ve just signed your loan application and are excited that you have “No Personal Liability” other than the carve outs for real estate taxes and environmental issues. The loan is:

• Nonrecourse
• 30-year term with a 10-year call
• Great rate with one point to the lender
• The loan is assumable to a new borrower for one point
• The lender must approve or reject the new borrower within 60 days

Great loan, what could go wrong?

Read and study the documents yourself, and know each nuance of the loan.

• Of course, you will have an attorney review the documents, but he’s not the one signing the loan.
• Know what each clause really means, and ask for lender clarification “NOW,” not after you have a problem.
• Right of offset—understand it.
• Attorney’s fees—try to get caps.
• Death of a partner is an event of default—have a right to replace the partner.
• Event of default, if the lender, determines: the loan is underwater because of a new appraised value, the debt service ratios are out of compliance, and the lender has a right to increase the debt service coverage ratio after the event.

The economy changes, you have vacancy, you didn’t hit your occupancy, and the lender claims an event of default under the terms of your nonrecourse loan.

No problem—we have a real estate tax escrow and a clean Phase I, so we’ll give the keys to the lender!

• If you’ve gotten to this juncture, the lender now wants to appoint a Special Servicer to service your loan. Special Servicers get paid, in addition to the servicing fee, Attorney’s fees, consulting fees, court fees and costs, fees for additional reports and reviews, etc., etc. Although they may also collect brokerage fees, they may not have an incentive to solve the problem because, in doing so, their fee income goes away.
• No knock on the legal profession, but it is not in the Servicer’s attorney’s best interest to resolve the Default quickly.
• You generally no longer control the property or any cash flow, and you pay your attorney’s fees out of pocket during the 12 to 48 months of battle.
• Hope you didn’t leave partnership money with the lender who was servicing the loan. Remember the right of offset? Your funds along with all escrow funds can be applied to the principal balance of the loan.
• You have a real estate escrow, but do you pay taxes in arrears? Then you could be held personally liable for the current year’s taxes, and the court battle continues on.
• You have a clean Phase I and so does the lender. The Servicer’s attorney argues that the lender does not know what could surface during the course of the Servicer’s control of the property, and the Servicer’s attorney wants the Environmental Indemnity to stand until the property is disposed of during the next 12, 24, or 36 months? You continue to defend the case because you have Personal Liability for the Environmental and the Real Estate Tax shortage.

Nonrecourse is not necessarily nonrecourse, especially if the loan goes into default.

Murphy says: An ounce of prevention is worth a hundred pounds of cure.

Understand the loan documents!

Upcoming article: If you think the loan is assumable for one point, think again!