Mortgage Loan Assumptions in Commercial Real Estate Purchase Agreements

By: Patrick Abell

Interest rates remain stubbornly high, and the forecast for rate cuts remains unclear. In this environment, commercial real estate buyers may need to consider creative financing solutions. Typically, non-cash buyers will encumber the property with a new loan at closing after seller pays off any existing debt. In the current market, however, buyers may want to explore whether they can assume seller’s existing mortgage, especially if seller’s interest rate is significantly lower than what is available to Buyer in the market. Buyer and seller should negotiate the process for executing the loan assumption in the purchase agreement. The purchase agreement should, at minimum, address the following key issues to facilitate a smooth loan assumption at closing.

Lender Consent

The parties will almost certainly need lender consent to the loan assumption. Sellers should be cautious about committing to obtaining lender’s consent to the loan assumption. Instead, they should only agree to use good faith commercially reasonable efforts to obtain such approval. Buyers may not be able to persuade sellers to make lender approval to a loan assumption a condition precedent to buyer’s obligation to close, so buyers may need to simultaneously pursue a traditional mortgage loan as a backup plan.

Seller Representations

Buyer should negotiate for representations from seller regarding the loan in the purchase agreement. At minimum, buyer should ask seller to represent that there are no defaults under the loan as of both the effective date of the purchase agreement and closing date. Seller should also represent that there are no items that, with the passage of time, would be likely to result in a default. Any risk relating to deficiencies or defaults in the loan existing prior to the closing date should be shifted to seller, with buyer assuming all obligations arising or occurring after the closing date.

Cost Allocation

If seller does consent to the loan assumption, there will likely be a loan assumption fee. Depending on the local customs and the terms of the loan documents, this fee may be negotiable between the parties. The fee should be allocated clearly in the purchase agreement to avoid a dispute at closing. Additionally, if the loan assumption is approved, the purchase price should be adjusted accordingly to allow for buyer to purchase seller’s equity basis in the real property at closing.

Assignment of Reserves

Buyer and seller should execute an assignment instrument assigning seller’s right to any loan reserves held in escrow at closing. Buyers should either take over the existing escrow account, or these funds should be assigned to buyer and processed through the settlement statement at closing.

Buyer Diligence in Lender Underwriting

From lender’s perspective, the buyer assuming the loan represents a new borrower. Lender’s underwriting team will need to perform appropriate due diligence. Seller should require buyer to use good faith and diligent efforts to promptly comply with all reasonable lender requests.

Loan Amendments and Documents

While buyer performs its due diligence on the actual real property, it also should thoroughly review the loan documents. Buyers should push for a contractual right to make reasonable amendments to the loan documents as a condition to their obligation to close the transaction. Further, lender will have a series of loan documents that both seller and buyer will need to execute at closing. The parties should include a provision in the purchase agreement obligating each party to cooperate in good faith and to execute such documents as reasonably requested by lender.

In conclusion, given the current financial climate, assumption of seller loans may present a strategy for buyers hoping to lower their cost of capital. To successfully execute a loan assumption, the parties need to work diligently through all lender requirements, and most importantly, address the loan assumption procedures in the purchase agreement.