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CRE Finance World, Summer 2014

Con-dos and Con-don’ts: The Financeable Commercial Condominium in CMBS 2.0 Geoffrey Maibohm A publication of Summer issue 2014 sponsored by CRE Finance World Summer 2014 59 n today’s CMBS world, borrowers and lenders alike tend to shy away from financing condominiums, fearing that a financing package will be difficult, if not impossible. However, an aversion to condominium financing is unnecessary if the underlying condominium collateral structured in a way that adequately protects the borrowers’ and the lenders’ interests. According to Warren Buffett, “risk comes from not knowing what you are doing.” With a solid understanding of what the CMBS market desires and requires when it comes to condominium financing, a condominium can and will remain a viable investment capable of being financed with no usual concerns. This article sets forth the market requirements for securitizing a loan primarily secured by a condominium and the pitfalls that lenders and their attorneys must work to avoid. A Focus on the Condominium Declaration The condominium structure is by no means a modern concept. Historians have unearthed a 4,000-year old Babylonian document recording the sale of a partial interest in a building1 and other historians have found evidence of condominiums among the ancient Greeks, Hebrews, Phoenicians and Egyptians.2 Today, however, condominiums typically come in one of four structures: commercial, residential, mixed-use (with both commercial and residential units) or site.3 To create a condominium, a declaration must be recorded in the same manner as a vesting deed. The declaration typically includes a legally sufficient description of the condominium units and the boundaries of each unit, a description of the common elements and limited common elements (if applicable), and must be binding on future owners of the land. It is this declaration that creates the interest in real property — an interest that is recognized and will be insured by a title company.4 Yet, creating an insurable interest in real property alone will not make a condominium financeable, particularly in the CMBS market. In addition to including a description of the common elements, limited common elements, cross easements, voting rights and/ or use restrictions, any condominium declaration should contain mortgagee provisions outlining where, when and how any mortgagee can enforce upon their condominium collateral. If a lender forecloses on a unit, the declaration should delineate how that process will work and what any lender will be liable for in terms of past or future assessments. The declaration will also confirm whether any consent of the condominium association or other unit owners is required for foreclosure (a condition that is unfavorable in today’s lending market). The declaration is the blueprint for all remedies available to a lender and should also provide any bona fide mortgagee the opportunity to receive notice of any event of default by a unit owner under the declaration, coupled with an opportunity to cure such default. Further, lenders will want to see mortgagee consent rights to major decisions of the condominium association including, but not limited to, the association’s right to terminate the condominium, the priority of any liens against a unit owner for unpaid assessments, or the percentage interests of any unit owner in the common elements. Any condominium declaration should also flush out all casualty and condemnation scenarios. In the event of a casualty, the lender will want the declaration to make clear that the association must rebuild the common elements of the condominium no matter how extensive the damage. If there is a significant condemnation of all or any portion of the units, particularly those units owned by the borrower, the lender will want to see that the declaration provides that the borrower and/or lender will be entitled to any award granted in connection therewith. CMBS Condominium Constraints When making a loan secured primarily by condominium property loan originators have little guidance from loan purchasers or rating agencies as to what is required. In ground lease transactions, there are industry-standard representations and warranties that each loan seller must make to any loan purchaser with respect to any ground lease. However, unlike ground lease transactions, there are few, if any, representations or warranties aimed particularly at condominium deals because every condominium declaration is very different and fact-specific. Nonetheless, there are key considerations that any lender or lender’s counsel should be discussing as soon as the condominium structure is disclosed. First and foremost, the condominium declaration should provide any mortgagee the right to foreclose on any unit and take title to any unit in the event there is a default under the loan — without the association having a right to prevent such foreclosure. Secondly, in any condominium where the borrower is not the only unit owner, lenders, loan purchasers and rating agencies will want to see that the borrower has control over the condominium association and the board of directors of the association (if any). Absolute control will mean that the borrower will have the right to make all decisions and control all votes with respect to the condominium without needing the votes or support of non-borrower unit owners. In some situations the borrower may not have absolute control, but will have a veto-right with respect to the association or the board of directors. This means that though the borrower will not have the power on the association or board of directors to make changes or decisions unilaterally, no other block of unit owners will be able to make any changes or decisions without having the borrower on-board. I Counsel Alston & Bird Robert Sullivan Partner & Co-Leader, Finance Practice Alston & Bird Elizabeth Murphy Associate Alston & Bird


CRE Finance World, Summer 2014
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