Commercial real estate financing can be particularly complicated and high-stakes when compared to other forms of borrowing — in part because the loan amounts are likely to be quite significant, and in part because commercial financing loans are secured by the potentially income-earning real estate itself (or related assets). As such, developers and other borrowers are best served by keeping apprised of the potential issues and exercising caution as they approach the commercial real estate financing process.
If you’re preparing to finance your next commercial real estate venture, then you’ll want to make sure that you engage lenders with the following issues in mind.
How an Assignment of Leases Works
In the commercial real estate financing context, an assignment of leases grants the lender landlord rights normally granted to the borrower, in a limited capacity. When the borrower defaults or owes some other obligation to the lender, then the lender is empowered to act as the landlord and collect rent to cover the debt (the lender gains a security interest in the rent from leases relating to the property at-issue).
How does it work?
Generally, an assignment of leases completely transfers the borrower’s rights under the leases over to the lender, who then grants the borrower a license to act as the landlord (this license can last for an indefinite or definite period of time). If the borrower defaults, however, then the lender is entitled to take back the license and operate as the landlord instead.
As a general rule, assignment of leases tend to be lender-friendly as they allow lenders to take control of borrowers’ rights as landlords under their lease(s) without having to go through protracted litigation.
You May be Required to Establish an SPE
Commercial real estate lenders can be particularly strict about how the borrower-developer or borrower-purchaser entity is structured. Specifically, a lender might require that the borrower set up a Single Purpose Entity (SPE), established for the specific purpose of developing and operating the real estate property at-issue.
SPEs are meant to operate independently of the borrower, and generally demand an organizational structure that enables this type of independence.
SPEs are useful to lenders because they enable lenders to better manage the risk inherent in large-scale commercial real estate development.
For example, suppose that the borrower is a large development company that develops many different commercial properties. The lender would only like to take on the risk inherent to one specific project in Bucks County, however. The lender requests that the borrower set up an SPE solely for the desired Bucks County project.
Were the borrower not required to set up an SPE, then the fate of other projects developed by the borrower could affect the lender’s interests — if the borrower had an unfortunate spate of failures, then it might go bankrupt. Because the lender requires that the borrower set up an SPE, however, the risk presented by the project at-issue is isolated from the risks presented by the borrower’s other projects.
Securing Mezzanine Financing to Fill in the Gaps
If you have not secured enough financing (with your equity and initial loan amount), then you may need to find additional, junior financing. In recent years, however, lenders have been resistant to allow junior financing where the junior loans are secured by the real estate property assets.
Mezzanine financing provides an alternative. Mezzanine loans are secured by an ownership interest in the borrower entity itself, not the real estate property assets (recall that borrower-developer entities are likely to have interests in multiple real estate projects). For example, if the the borrower defaults on their mezzanine loan, then the junior lender may step in and take over its assigned interests in the borrower entity.
Call (610) 260-6000 to setup a free consultation with a Bucks County real estate lawyer here at Kaplin Stewart. We look forward to speaking with you.