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Anticipatory Drafting: Documenting the Release Parcel on the Front End

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Borrowers, at the initial loan closing of an acquisition of investment real estate, often have plans to later develop and/or convey a smaller portion of the real estate collateral.  However, depending on the size and nature of the lender, and the importance of the subject parcel, it may be expensive and/or time consuming to obtain the lender’s consent to release the parcel from the loan.    An alternative strategy is to provide, in the initial loan documents, for the permitted release of the parcel or outparcels under which sale or development is expected to occur. However, it is critical to specifically designate the release property in loan documents beforehand. Understandably, releasing a portion of the real estate collateral will present a number of practical considerations for the lender.

If the parcel is expected to be released as collateral from the loan, the lender may require that it be excluded from the initial valuation (which may affect available loan dollars) or that the release parcel be separately appraised at the time of loan origination (or prior to construction), in order to establish a “release price” at the time of the anticipated future construction. The lender will also need the release parcel to have a separate tax parcel number and comport with all subdivision requirements.

Further, the release of the parcel, after closing, could result in a violation of special purpose entity (SPE) covenants in the loan documents, unless it is conveyed to a new entity. Allowing a borrower affiliate to own the property adjacent to the collateral may cause lender to have concern with conflicts of interest among owners, and the lender will want controls and restrictions over the release parcel to prevent these kinds of issues. The lender will not want to allow the release of the parcel, unless it has assurance that it will not result in operational issues with the remaining collateral. The lender will want to confirm that any necessary tenant or third-party consents have been obtained, in connection with any subdivision or release of collateral. The lender may insist on the recordation of cross-access easements to cover access, maintenance, and other operational issues to govern the coexistence of the parcels as separate properties.  The lender may condition the future release of the release parcel on whether the remaining collateral will satisfy certain financial metrics. The issues referenced above are non-exhaustive, and the host of lender concerns with releasing a portion of the real estate collateral underscore the need to clearly document such parameters clearly and preemptively. To minimize unbudgeted time and expense in obtaining the lender’s consent down the road, it is important that an attorney be engaged to properly memorialize and capture such nuances.

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