Single Family Residential Portfolio Financing: The Pixilation of Commercial Real Estate loan documentation, acquire a new property in the future will want to make sure that it does not inadvertently breach a representation or a covenant by doing so. Issues Related to Property Management. With hundreds to thousands of properties located across states and different localities within those states, borrower/owners will often need to contract with more than one property manager and will have to rely on those management companies even more so than with the more traditional single property asset. Although many aspects of multifamily arrangements can be brought to bear in the documentation for an SFR portfolio loan, there are significant differences. And although big national companies are certainly moving into the SFR space, companies managing SFR properties are less likely to be accustomed to practices traditionally used in CRE financings than are commercial management companies. This becomes evident as various arrangements involving the managers are put into place. The management agreements must of course be subordinated and made subject to termination by the lender. Lockbox arrangements are normally required, so owners may have to explain to property managers (who may be accustomed to simply deducting their fees “off the top” of receipts and passing the remainder along to the owner) why they now have to remit all receipts and wait for the waterfall to run its course. Creative solutions “The diversification of some property risks that are inherent in the SFR collateral can wind up being the solution to some of the unique problems arising from the asset class.” such as reserve, escrow or “slush fund” arrangements with property managers might be required. Representations and Warranties. Representations and warranties can normally be made in much the same fashion as with more traditional collateral types. However, the same factors that limit due diligence investigations on the lender’s part (and probably limited investigation on the borrower’s part at the acquisition phase) must be considered here as well. A borrower is well-advised to employ qualifiers related to knowledge and materiality (and the lender should agree to this) on those property-level representations that are the subject of truncated due diligence. Casualty and Condemnation. The granularity of the collateral is very much a factor in negotiating limits for casualty and condemnation thresholds – what amounts can be retained by the borrower and applied to restoration without participation by the lender, what amount triggers an election by the lender to apply proceeds to the repayment of the loan, etc. The thresholds may be better based on CRE Finance World Winter 2015 16 allocated loan amount for each property rather than the amount of the entire loan. In addition (even in cases of damage that is very significant with respect to a specific property, but is still small as compared to the loan amount), it may not be practical for the lender to require the usual draw process and related monitoring of the work as it progresses (i.e. title endorsements, contractor waivers etc.). Lenders can be expected to argue for low thresholds, on the basis that any specific casualty or condemnation event can be expected to affect only one property – and therefore a miniscule fraction of the collateral. Indeed, even a relatively low (as compared to other CRE financing arrangements) threshold as a percentage of loan amount should give the borrower ample latitude in addressing any casualty or condemnation event that is likely to occur. Special Secondary Market Considerations. Especially in view of the fact that this asset class is a newcomer to the multi-borrower securitization arena, lenders might want to hedge their bets by creating as many options as possible for secondary market transactions. For instance, foreseeing some resistance by investors to exposure to this asset class, lenders may bargain for the right to split the portfolio, or to “uncross” loans that are cross-collateralized and/or cross-defaulted when made. Some hazards exist here for borrowers. Any agreement to split loans in the future by creating new portfolios can carry significant costs such as transfer costs to newly formed entities, entity creation costs and “no substantive consolidation” opinions. In addition, carving up existing SFR portfolios can wreak havoc on LTV and DSCR ratios unless the property selection process for the new (smaller) portfolios is carefully considered. While a borrower will be sympathetic to the lender’s desire for this kind of protection, the issues of cost allocation and effect upon portfolio performance would require thoughtful negotiations. Going Forward As the SFR asset class matures as a source of collateral for commercial real estate mortgage loans, as the investment community comes to understand it and get comfortable with it, and as borrowers and lenders in the space identify and deal with the challenges of the class, accepted practices and documentation will settle into place. Both business people and lawyers engaged in these transactions as that process unfolds will have the opportunity to shape those arrangements as they work with this unique class of collateral, which is simultaneously residential and commercial.
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