Condominium Lender Requirements

Condominium lenders take on a great deal of risk when financing condo construction and because of that there is much work that must be done in document execution …

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Condominium lenders take on a great deal of risk when financing condo construction and because of that there is much work that must be done in document execution before ground is broke. Due diligence must be enforced in adherence to state condo laws to be sure that the property is marketable after completion, and the purchase agreement must stipulate there will be an adequate number of sales. For this reason, lenders are likely to take special care to avoid any mistakes in documenting the legal responsibilities with the developer and other parties with a stake in the contract. For more on this continue reading the following article from National Real Estate Investor.

Financing condominium development involves a great deal of risk as a result of the nature of a condominium and the government’s involvement in the process of creating, selling and, sometimes, operating residential condominiums. The due diligence prior to making the loan, the drafting of the loan documents, and the supervision of the sales process require unique knowledge and experience because of the potential for lenders to unintentionally become involved in either a state investigation or unit owner disputes even after the construction is completed and the loan repaid. 

Due diligence

 As a result of the unusual nature of condominium construction financing, the due diligence review must include an analysis of: the condominium’s declaration, by laws, and other formation and governing documents; the state condominium act and, if applicable, the securities laws of the state or states where the units will be sold; federal securities and consumer protection laws, which could impact sales; the purchase and sale or other agreement that is to be used for the purchase of the individual condominium units; sales and marketing materials to be used in the sale of the units; and the borrower/developer’s compliance with the foregoing requirements in developing the property and closing the units.    

The construction lender’s largest concern must be to be certain that, upon completion of the condominium’s construction, the units are marketable and that the condominium’s common elements and units are in conformance with the law, regulations, and offering documents as well as the traditional lender concerns relating to compliance with local municipal codes and construction practices and procedures. The fact that the construction may be completed, a certificate of occupancy issued and the declaration of condominium forming the condominium is recorded, does not necessarily mean that the units can close and the loan can or will be repaid.  

Purchase agreements

The purchase agreement for the units is an extremely important document since it is the basis pursuant to which the loan will be repaid, although a review of the purchase agreements is frequently overlooked by lenders. There are two primary concerns in reviewing the purchase agreement are making certain that the purchaser is obligated to close and the developer is not obligated to close if it will have an adverse impact on the lender. These issues require that the purchase agreement clearly defines the obligations of the purchaser and that the purchase agreement does not contain conditions that the sponsor (or the lender) will not be able to meet.  However, the lender will not want to be forced to close if there is likelihood that there will not be a sufficient number of sales. The last thing that the lender wants is to do is proceed with dividing the property into units and common elements and then find out that, because of the insufficiency of sales or a changing market or economy, only 15 percent of the units are sold and the lender finds itself in a de facto "partnership" with the owners of a minority of the units, who have a different agenda than the lender. Of course, the purchase agreement cannot provide that the closings do not have to occur if the lenders does not want to close, but the loan agreement can provide that the sponsor cannot execute a purchase agreement unless the sales price is above a certain minimum release price and that the closings cannot commence unless there are a minimum number of binding purchase agreements usually expressed as either an aggregate amount of sales or a certain number or percentage of units. 

The lender should also make certain that the purchase agreements will be enforceable under state and federal law and that the purchasers do not have any rights to rescind their contracts, which could permit them to terminate the contracts without a forfeiture of their deposits.  This is also why the lender needs to know whether a filing should be made under the Interstate Land Sales Full Disclosure Act and that neither  federal or state securities laws or consumer protection laws will be violated by the offering or closing, which could provide the purchasers with the right to rescind their purchase agreements.    

The offering materials

The relationship between the developer and the condominium association and its unit owners is largely dependent on the law of the state in which the condominium is located (and, in some instances, the state where sales are made) and the terms and conditions contained within the offering materials (the "POS").  Although the POS cannot contradict the provisions contained within the local condominium law, and the federal and state securities laws that relate to the offering of securities, in general, and condominium units, in particular, the POS may contain specific limitations on the obligations of the developer and the unit owners.  Moreover, many states provide the developer with special rights and limitations on those rights in order to permit the expeditious completion of the residential development, provide the unit owners with the ability to control their destiny, make certain that the developer fulfills its obligations under the law and the POS, and provide comfort to the construction lenders.  Since purchasers would be able to rescind their purchase agreements and have their deposits returned for material misstatements or omissions in the POS or otherwise claim that they were damaged if relevant information became unavailable after the closing, the lender will want to be certain that the state’s offering requirements are satisfied. 

Conclusion

There are many significant issues for a lender to consider in making a senior loan or mezzanine loan in the development of condominiums, which requires caution for the lender.  Of course, except in unusual circumstances, the loans are repaid without incident, but the lender must proceed carefully because of the complexity of such loans, the numerous parties with interests in the property besides the borrower and lender, and black swan events.

This article was republished with permission from National Real Estate Investor.

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