Commercial Real Estate Loan Fundamentals: How To Manage Lender Due Diligence

Your business likely has real estate assets

Your business likely has real estate assets. One way to unlock the value of those assets is through a well-executed commercial real estate loan. What should you expect during the loan closing process? Here is a description of the primary lender due diligence items and how to successfully negotiate each loan closing requirement.

Environmental Site Assessment (ESA): Your commercial lender will require an environmental survey of the property. Lenders are keenly aware of the potential financial exposure from a long list of environmental contaminants and use the ESA as a risk mitigation tool. Ask your lender to use the consulting firm that has previously surveyed your property. This may save time and money because the tedious historical research has already been completed. Be prepared to deliver your operations and maintenance plan if the property has existing environmental issues. The ESA is a long lead time item so get started early in the closing process.

Physical Site Assessment (PSA): Like the ESA, the PSA is conducted by an independent engineering firm. Arrange for your property manager to accompany the engineer on the inspection to provide access to areas of the property that house critical building systems. The property manager should be available to answer questions and may be asked to complete a building questionnaire.

Property Zoning Report (PZR): The zoning report is required by lenders to ensure compliance with all local, state and federal property restrictions. Governments have authority to impose restrictions on property use. For example, certain neighborhoods may restrict industrial property uses. The PZR will disclose any zoning violations as well as a detailed explanation of the current property zoning and stipulations. Use a third party zoning report consultant instead of trying to secure a zoning compliance letter from the local government. You will save time and get a report that will meet the lender requirement.

Survey (ALTA): An accurate measurement of the land and buildings is essential to determine the exact collateral that will secure the new loan. You can save time and money by using a firm that has previously surveyed your property because an update can be made quickly. Be sure the surveyor has the list of survey requirements from the lender to avoid a closing delay.

Preliminary Title Report (PTR): One of the first items to order is a preliminary title report from a title insurance company that is acceptable to the lender. Try to use the title company that has provided title insurance on this property or others in your portfolio to save time and possibly get preferred customer pricing on title services. This is a long lead time item because the chain of title must be researched by the title company. Review the PTR for exceptions to title insurance which may include recorded liens, a lease memorandum or other clouds on title. Clear as many of the exceptions as possible before closing by providing supporting documentation to the title company. Also look at the requirements from the title company such as organizational documents and get those cleared well ahead of closing.

Appraisal: The appraisal firm hired for your loan closing will determine the property value which directly impacts the loan amount. Many lenders will require an internal review of the draft appraisal to ensure accurate and fair valuation assumptions were used. Review the draft appraisal for accuracy, especially financial data, which impacts the capitalized value. Look for missing income and inflated expenses that impact the net operating income calculation. Evaluate the comparison property sales and push back on the appraiser if they are not reliably comparable.

Utility Will-Serve: If you are closing on a construction loan the lender will probably require letters from all the major utilities indicating they will provide service to the property upon completion. This is a fairly easy form letter to get from your local gas, electric, water and cable provider.

Estoppels and SNDA's: The borrower or borrower counsel is usually responsible for completing, distributing, tracking, collecting and returning these legal documents to the lender prior to closing. The lender typically provides a form document with placeholders to merge tenant lease data. Ask your attorney to review the documents prior to sending to your tenants. Negotiate with your lender to limit the requirement and return less than 100% of the total leases. Lenders will usually insist on getting these documents from your major leases. Get started early because these are a long lead time item.

These and other requirements stand between you and your loan closing. Get organized with a complete loan closing checklist, adequate staffing and a clear line of communication with your lender and third party providers to enjoy a successful loan closing.

by: Michael Shelton

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