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What are the typical providers of real estate financing in your jurisdiction? Are there any restrictions on who may provide financing?
Commercial mortgage-backed securities (CMBS), which are US public markets securities issuances, form over 20% of the real estate debt market capital. In addition, bank lenders provide the bulk of debt capital to the real estate markets, at approximately 40% (almost evenly split between domestic and foreign banks) and increasing potentially to a historic level of almost 60%. Bank lenders are followed by private/other sources at 18%, followed by life insurers, government supported entities (for multifamily assets) and non-bank sources, including real estate funds and real estate investment trusts.
CMBS underwriting became more conservative in 2016, with loan-to-value ratios declining from 64.3% in 2015 to 58.7% in 2016 and debt service coverage ratios increasing from 1.82 in 2015 to 2.14 in 2016. CMBS issuance as a source for debt refinancing is expected to decline further in market share in 2017, due to the effects of the risk-retention rule, which took effect in 2016 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The risk-retention rule requires that issuers retain a minimum of 5% of the risk in their CMBS issuances, as a ‘vertical slice’ across all tranches, a ‘horizontal slice’ at the lowest tranche, or an ‘L-shaped slice’ combining vertical and horizontal interests.
What are the most common structures used to secure real estate financing and how are these security interests perfected?
The most common forms of security for a real estate loan are:
- a mortgage, which creates a security interest for the lender in the real estate; or
- a mezzanine pledge, which creates a security interest for the lender in the ownership interests in the entity that owns the real estate.
A first-priority mortgage is given to the most senior lender, typically with a loan that does not exceed 50% to 75% of the property value. If larger amounts are borrowed, the additional loan will be junior in priority to the mortgage loan and secured by a pledge of the ownership interests in the entity that owns the real estate, not the real estate itself.
What covenants are typically made in financing agreements?
Borrower covenants in mortgage financings include:
- payment of debt;
- grant of security interest in property and leases;
- rents and proceeds of mortgaged property;
- covenants against junior liens;
- maintenance of borrower entity as a single-purpose entity;
- maintenance of mortgaged property;
- operation and leasing of mortgaged property;
- rebuilding in the event of casualty and condemnation;
- use of the loan proceeds; and
- recourse to borrower or guarantor credit if certain adverse events occur.
Enforcement of security
How are security interests enforced in the event of default?
When a first-mortgage lender forecloses on a mortgage collateral to enforce its loan, it will hold a sale of property title to receive repayment on its loan and will wipe out all junior liens, including a mezzanine pledge, in the event that the sale proceeds are insufficient to pay off claims.
When a mezzanine lender forecloses on its security interest in the ownership entity, it will take title to the ownership interests of the property, subject to the mortgage, and the mortgage will remain intact. Both mortgages and security pledges are subject to – and enforced under – state law. While details of the enforcement process vary from state to state, lien priority issues are generally similar. In CMBS, where mortgage loans are pooled into a single trust and securities of differing priorities are created in the trust, enforcement of the underlying mortgages follows the same state law process as for single loans.
What is the typical timeframe for the enforcement of security?
Foreclosures are governed by state law for both mortgage collateral and mezzanine collateral. Mortgages are typically enforced through a court-ordered foreclosure process that can last from six to 18 months. Mezzanine loan enforcement, which involves a sale of the pledged ownership interests under the Uniform Commercial Code, is much quicker – typically 60 to 90 days. Notice procedures to all parties affected by the foreclosure are prescribed by state law and must be strictly adhered to.
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