This edition of the REO Advisor explores the pre- and post-foreclosure servicer strategies to allow for tenant construction activities on collateral properties, as well as the subdivision and subsequent partial sales of large REO properties.

Example 1. As part of its pre-foreclosure due diligence, the special servicer learns that a tenant (muffler shop) wants to expand its store location at the collateral property (a retail center) by constructing two new service bays attached to the service bays that the tenant currently occupies. The borrower’s loan is in default and the tenant has not started the construction of the new service bays. Can the special servicer allow the tenant to construct the additional service bays prior to or following foreclosure?

Answer: Maybe, but only if the tenant completes all construction prior to foreclosure. Provided tenant completes all construction before the REMIC acquires title to the retail center, the retail center (including the tenant's expanded space) should be considered qualified “foreclosure property” despite the fact that construction took place on the property prior to but in anticipation of foreclosure. The special servicer must understand, however, that unlike in the case where the tenant completes the construction prior to foreclosure, there is no way for any of the tenant's construction to take place once the REMIC has acquired title to the retail center as foreclosure property. In this example, the completion-of-existing-construction exception to the new construction prohibition on foreclosure property is not available to the REMIC as the tenant had not started the expansion before the borrower’s loan default was imminent. In cases such as this, the special servicer must weigh the benefit of having the property improved by the tenant prior to foreclosure against the cost of delaying the foreclosure until the tenant completes the construction. See Kilpatrick Townsend, Servicer Survival Guide 2017-2018 Edition, Merri McCoy and Bob Stupar “An Ounce of Prevention—Pre-foreclosure Planning" for a detailed discussion of the technical rules that apply to construction activity prior to and following foreclosure; See also Kilpatrick Townsend, REO Advisor 2017, Vol. 1.