Nov 3, 2022 10 Min read
In the current economy, financing the purchase of a commercial property can be difficult. Mortgage lenders are cautious about whom they lend money to, and now that is even more pronounced as the market has become more volatile.
For this reason, some prospective commercial real estate buyers are considering taking advantage of loan assumption opportunities to finance their real estate purchases. In this post, we will discuss an assumption loan, why it's important to understand, and what to expect when assuming a loan.
The concept of assuming a loan is quite simple. Just as its name suggests, a real estate buyer purchases property by taking over the loan obligations of the seller on the same terms the seller negotiated upon originating the loan. These include:
However, for a property buyer to assume a seller's existing loan, the initial loan contract must have had an "assumption clause." This is a provision in a mortgage agreement that allows a real estate buyer to assume a borrower's loan, provided they meet the lender's qualifications such as:
But which types of loans are assumable? Not all commercial real estate loans are up for assumption. The main types of mortgages that can be assumed, provided all requirements are satisfied, include:
Loans that originated through Freddie Mac, Fannie Mae, and FHA/HUD are typically assumable. Generally, most of these loans are non-recourse loans and longer-term fixed loans. This can be attractive to many seasoned investors.
Loans originating through a CMBS (Commercial Mortgage-Backed Security) can also be assumed if negotiated into the loan agreement before closing. These loans, like agency, are also non-recourse loans that typically have a favorable fixed term structure that seasoned investors will find favorable in a high-interest rate environment.
These loans originated through a Life Insurance company that invests in first liens through the origination of commercial loans. Very similar to CMBS these loans also have to be negotiated to have language in the loan documents be assumable.
Loan assumption holds several advantages for potential commercial real estate buyers if a seller has an assumption right in their loan contract. Some of the benefits a transferee stands to gain in such a scenario include the following:
Better loan interest rate: In the current environment where interest rates are increasing, assuming a loan with a lower rate than the prevailing industry rate can save buyers thousands in debt service savings.
Potentially better loan structure: Assuming a loan originated in a different time when the market was more aggressive can allow an investor to still get a loan that would be very difficult to obtain in today’s market. An example would be a property that is now performing not as well as previously anticipated and still has interest only a period left on the note. A new lender would not approve an interest only but since it’s still part of the previous loan the new buyer can take full advantage of this.
Because of all this, assuming a loan is an enticing prospect to many potential property buyers. However, buyers should ask for and review all loan documents to ensure they're getting into a deal that makes financial sense.
Although the loan amount in an assumption is less than that of a new loan, it's best to evaluate all the loan documents when doing an assumption. Some of the things to be aware of in an assumption include the following:
One area to keep an eye out for is high down payments, especially when a seller's property has increased equity. When the property’s equity value is higher than the previous purchase price the down payment could be significantly higher.
In most cases, where a buyer doesn't have a sufficient down payment, they might need to take out a second loan called a "supplemental loan" to lower the equity requirements. Only a select group of loans that allow assumptions also allow supplemental loans. We suggest reaching out to a commercial loan expert at Terrydale Capital to know more about those loans.
In some cases, a seller may want to sell due to issues with the performance of the property. If this is the case, there could be loan covenants that require additional capital, activations of a lockbox, and/or additional measures to make sure the property gets back on track from the lender’s point of view. In these cases, you could be taking on someone else’s problem. Make sure you are asking the right questions about performance and working with a commercial real estate professional to double-check no provisions could be triggered right after closing.
Loan assumption opportunities can be a cheaper alternative for buyers looking to purchase commercial property in today's harsh economic climate. However, as lucrative as this opportunity may be, buyers should review assumption provisions carefully before making a final decision.
Buyers should review the loan documents and agreements the seller and lender made during the original loaning process. Any changes to loan terms made in the loan agreement before the assumption should be availed to the buyer. Remember, many loan provisions and agreements are subject to negotiation.
Reach out to Terrydale Capital if you want a quick guide through the loan assumption process. We provide a detailed breakdown of the process, including the pros and cons, and help you evaluate the best market options.
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