5 Things to Consider Before Assuming a Loan

Gil Uhlhorn

As real estate sellers and purchasers adjust to the current lending and interest rate environment, loan assumptions are once again becoming an important tool for closing, particularly for stabilized properties with existing commercial mortgage-backed securities, life company or agency debt.

Under the low interest rate environment that existed for many years in the commercial real estate market, the assumption of an existing loan in connection with a real estate acquisition was not a popular structure, given the relative ease of closing on new acquisition financing or even acquisition or renovation financing. In fact, while negotiating loan documents in the recent cycle, most borrowers did not pay particular attention to the loan assumption provisions in their loan documents. Instead, they focused energy (and comments) on other important facets of the loan, such as financial covenants and reserve requirements.

However, sellers in today’s market are finding that a low-rate, assumable loan is an attractive option for many potential purchasers. This loan assumption gives potential purchasers the ability to transact at a value that aligns more closely with the sellers’ original underrating expectations for an exit. However, potential purchasers need to be thoughtful about the assumption process and consider a variety of factors that might not be applicable in connection with new loan origination.

Initially, potential purchasers should pay attention to the following five factors:

1. Loan Documentation: Potential purchasers/new borrowers and their advisors need to review and carefully consider the specific deal points set forth in the loan documents. There are often deal-specific or borrower-specific terms beyond the principal loan amount, rate, payment schedule, maturity date, etc. that potential purchasers/new borrowers need to understand since the potential purchaser/new borrower is required to abide by those terms for the remaining life of the loan. Often, the existing lender will not be willing to make changes to the existing terms and, if the existing lender does consider revisions, any requested changes will lengthen the closing time and increase closing costs.
2. Replacement Guarantor: Potential purchasers/new borrowers need to accept the terms of any existing guaranty and be prepared to provide a replacement guarantor acceptable to the existing lender. Often there will be specified requirements for such replacement guarantors related to net worth, liquidity and/or market experience. The approval process of the replacement guarantor will run smoothly if the potential purchaser/new borrower has all information and financials ready to share with the existing lender for the replacement guarantor/sponsor at the time of submission of the loan assumption application.
3. Structure Requirements: Potential purchasers/new borrowers need to look closely at the structure of the existing borrower and the structure required by the loan documents. There will often be special purpose entity requirements that will dictate how the borrower must be structured. Potential purchasers/new borrowers will need to be able to satisfy those requirements or work with the existing lender to revise those requirements to meet their needs.
4. Permitted Transfers: Potential purchasers/new borrowers need to understand what upstream transfers of ownership interest in borrower, if any, are permitted under the existing loan documents and determine if such permitted transfers work within their current structure and business model. For example, real estate funds or limited partnerships will often want the ability to transfer upstream noncontrolling interests without lender consent and the existing loan documents may not provide for such transfers.
5. Cost and Time:  Potential purchasers/new borrowers need to review the existing documents to estimate the time and cost associated with the loan assumption process. Often, in addition to requiring the payment of all out-of-pocket costs and expenses (including attorney fees) incurred by the lender in connection with the loan assumption, existing lenders will require payment of a review fee with the assumption application, along with a transfer fee to be paid at the closing of the loan assumption. The assumption fee is generally based on the outstanding principal balance of the loan. The party responsible for paying these fees can be negotiated by sellers/existing borrowers and potential purchasers/new borrowers. Also, the loan documents generally provide a basic timeline for the assumption process, but potential purchasers/new borrowers should include some additional time as a variety of factors could increase the basic timeline set forth in the loan documents.

In today’s market, many potential purchasers will consider the ability to assume an existing loan a major plus when evaluating a property, and an assumable loan should help sellers realize higher purchase prices. But it is important that potential purchasers do some upfront diligence to make sure they are assuming a loan that works for their needs at a reasonable cost and within an acceptable timeframe.

 Gil Uhlhorn is a member at Bass, Berry & Sims’ Memphis, Tennessee office. He advises clients on the acquisition, disposition and financing of real estate assets. He also assists with long-range planning, leasing and day-to-day issues encountered by real estate owners.