Negotiate ‘Financeable’ Leases to Obtain Future Loans

In today's stagnant economy, the Federal Reserve is aggressively cutting interest rates in an attempt to spark the economy. The rate cuts are giving property owners an opportunity to refinance and purchase new properties or to tap existing properties' equity for operating capital.

Lower interest rates, however, don't necessarily mean it will be easy to get a loan. If your collateral is your building or center, your lender will be concerned with more than just the property value—it will also assess the quality of the lease agreements you have with your tenants.

When lenders consider approving a loan, more than anything else, they want to protect their interests and make sure that they get repaid on a timely basis. If your commercial property is securing the loan, the lender's evaluation will take into consideration the types of leases that exist with your tenants.

Ideally, lenders look for “financeable leases”—leases that ensure consistent cash flow and have terms that would protect a lender from liability in the event that the lender has to foreclose on the property and step in as the new owner, says Miami real estate attorney Pilar Bosch.

Tenants are concerned primarily with making sure that no matter what happens with the ownership of the property, as long as they are operating in accordance with their lease, their rights will not be altered in any way and they will be allowed to remain in their space after a foreclosure, Bosch adds.

This puts you in the middle, as both the lender and tenant are looking to you to ensure that their financial interests are protected. Getting the two parties to come to a mutual agreement involves negotiating two very sensitive items—the tenant estoppel certificate and the subordination, non-disturbance, and attornment agreement (SNDA). If not handled properly, the two documents can cause major problems between you and your tenants—or even worse, it can cost you your loan, warns Bosch.

With Bosch's help, we'll explain what the tenant estoppel certificate and SNDA are and how they facilitate your loan application process. In addition, we'll give you eight lease strategies to help put you in the best possible position to have a loan approved by your lender.

What Is the Tenant Estoppel Certificate?

The tenant estoppel certificate is a document signed by your tenant for the benefit of your lender or the purchaser of your commercial property. This document confirms that your tenants' leases are enforceable and that there are no uncured defaults under the leases, says Bosch. Typically, your lender will draft the certificate and require the tenant to confirm the following:

• The actual start date of the lease and the square footage of the space;

• That the lease is accurate and in full force and effect;

• That the tenant has accepted the space and is currently occupying it and paying all costs associated with the space, and that any tenant improvement allowances owed it under the lease have been paid by the owner;

• The amount of the security deposit paid or to be paid by the tenant and that the tenant has not paid any other amounts to the owner other than the security deposit and rent;

• That the owner has not defaulted under the lease and the tenant has no knowledge of any owner action that would place the owner in default; and

• That the tenant has no claims or defenses against enforcement of the lease.

Before applying for a loan, review your leases to ensure that they obligate your tenants to provide an estoppel certificate upon your request, says Matthew C. Alshouse, an attorney in Baker & McKenzie's Chicago office. Pay particular attention to the time required for turnaround, and look for any pre-approved estoppel certificate forms. Some tenants agree to an estoppel requirement only if they get to use their own form. You'll need to bring these forms to a lender's attention to keep the lender's expectations in line with what you can reasonably obtain.

Practical Pointer: It is unlikely you'll get 100 percent of your tenants to sign an estoppel certificate in time for closing on the financing, even if your leases require a timely turnaround, says Alshouse. Therefore, identify the major tenants the lender really cares about and agree to get estoppels from them, and perhaps a percentage from the other tenants, he says.

What Is the SNDA?

The SNDA is actually three separate agreements that are commonly used in commercial lease transactions—the subordination agreement, the non-disturbance agreement, and the attornment agreement, explains Bosch.

Subordination agreement. The subordination agreement, which is usually requested by the lender, requires the tenant to agree that the interests of the lender take priority over its lease, says Bosch. If the owner defaults on its loan and the lender forecloses on the property, the lender would not be responsible for any of original owner's lease defaults once it takes possession of the property.

Moreover, in the event of a conflict between the provisions of the lease and those of the mortgage and other instruments securing the loan, the lender would want the provisions of the security documents to trump the lease provisions. This is the “rub,” as the tenant will fight to preserve its rights and entitlements under the lease at all costs.

Editor's Note: Lenders hesitate to rely on the automatic subordination provision included in most standard commercial leases, as they may not be exclusive to the specific lender and do not cover specific lease modifications the lender may require. In addition, says Alshouse, the breadth and effect of a blanket subordination clause may be interpreted differently by courts in varying jurisdictions at different times.

Attornment agreement. The attornment agreement is actually woven into the subordination agreement. Here, the lender is following its demand for tenant subordination with a request for the tenant to recognize any new owner that may take over as a result of default and foreclosure, explains Bosch.

Non-disturbance agreement. The non-disturbance agreement is usually requested and negotiated by the tenant after it receives the lender's request for a subordination agreement. In other words, the tenant will usually agree to sign the subordination agreement in exchange for a written promise guaranteeing that if, upon foreclosure, a new owner steps in, the tenant's lease rights will not be affected, as long as it is not in default of the lease, Bosch explains. The non-disturbance agreement is particularly important for future mortgages where the existing tenant, whose interest has priority over the new mortgage lien, gets an opportunity to negotiate the terms of the subordination.

In short, the tenant estoppel certificate confirms that the lease is enforceable, and the SNDA memorializes the agreement in which the tenant acknowledges: 1) that its lease is subordinate to any future mortgages; 2) that as long as the tenant is not in default of the lease, it will not be affected by the owner's loan default and subsequent foreclosure; and 3) if the lender or a new owner steps into the shoes of the original owner, the tenant will acknowledge the new owner as the owner of the building or center.

Why Lenders Demand Estoppel Certificate and SNDA

Simply put, getting your tenants' signature on the lender's tenant estoppel certificate and SNDA is important because without the two, the lender will probably deny your loan application, says Bosch. Without those key documents, the lender would be exposed to a significant level of unacceptable uncertainty and potential liability, she says.

Consider what could happen if the lender forecloses on the property and steps in as the new owner, but there is either no signed tenant estoppel certificate acknowledging no ongoing default issues on the part of the owner as of the loan closing date or no SNDA stating which of the original owner's obligations the new owner would assume.

First, the lack of a signed tenant estoppel certificate could allow a tenant to claim that there are a number of ongoing issues with the lease for which the tenant may then seek relief, warns Bosch. This claim could ultimately lead to tenants leaving your building or center, which would disrupt the consistent cash flow that lenders look for when deciding whether to approve loans, she adds. Especially in the case of major or anchor tenants, a lender will not underwrite its loan without knowing that, at the time of funding, there are no outstanding owner liabilities and no defaults on the horizon.

Next, without an SNDA, the lender could potentially be responsible for all provisions in the tenant's original lease, regardless of how damaging they are to the lender's interests, says Bosch. Some examples of the types of provisions that the lender/ new owner could be responsible for include:

• Paying for any and all tenant improvements;

• Paying for restoration after casualty or condemnation;

• Having to honor rights of first refusal or options to purchase; and

• Having to honor early termination and renewal rights.

Lease Strategies to Help Secure Your Loan

To enhance your chances for success with your lender, Bosch suggests implementing the following eight strategies to make your leases more “financeable.” This list is not meant to be exhaustive, and you should consult your attorney when drafting your leases. However, by considering these eight strategies, you can make your leases more attractive to lenders while meeting your tenants' requirements.

Make sure lease covers basics. In determining the consistency of cash flow from your property, the first thing that a lender will do is confirm that your leases are enforceable, says Bosch. It will look to see if your lease clearly identifies all parties involved and defines their rights and responsibilities. Some of the basics include:

• Naming the tenant and clearly identifying all space that the tenant will lease and have access to during the lease term;

• Clearly stating the amount of rent to be paid and that the tenant may not pay more than one month in advance; if rent bumps are determined by reference to CPI or some other index, be sure to add a requirement that the parties enter into a certificate confirming the rent;

• Clearly stating the term of the lease and any options to extend or expand. The lease should list the conditions that must be met to exercise the option;

• Tying the exercise of lease rights (such as options to renew, rights to expand, etc.) to there being no tenant events of default at the time of exercise; and

• Requiring the tenant to sign an estoppel certificate and your lender's form of SNDA within a short time frame after receiving a request to do so (if available the form should be attached to the lease).

Limit assignment and sublease options. Overly broad assignment and sublease rights raise red flags for lenders, as they want to rely on the creditworthiness of the original tenant. Include specific net worth tests for assignment and sublet; make rights to expand, renew, and the like personal to the original tenant; and add a provision in your lease that states that the original tenant will not be relieved of its obligation to pay rent if it sublets or assigns the space, unless the owner and lender (if applicable) give written approval, says Bosch.

Limit tenants' right to terminate lease. Lenders like to see leases with very limited or no termination rights—exceptions can be made that allow for a tenant to terminate its lease if the space is destroyed by casualty or condemnation and cannot be repaired in a reasonable amount of time, says Bosch.

Limit owner's obligation to repair or restore. Be sure to limit your obligation to repair or restore the space to only the amount received from insurance proceeds after a casualty, says Bosch. You'll also want to make sure that the insurance provisions in your lease are compatible with the casualty and condemnation provisions, she adds. The lender will also seek to be the ultimate arbiter of the application of insurance proceeds and proceeds from condemnation.

Be specific with exclusive use clauses. In some cases, your larger tenants will negotiate for the exclusive right to sell their products in your building or center. If you want to put your lenders at ease and cut down on conflicts with future tenants, limit the exclusives clauses to only the primary product or service that the tenant provides, says Bosch.

Eliminate set-offs against rent. Lenders often deny loans where the leases involved allow for set-offs against rent, warns Bosch. For example, if your lease has a provision that allows for the tenant to reduce its rent by the amount that it had to pay to make repairs not completed by the owner, a lender would probably view the set-off as a threat to the building or center's cash flow and ask you to amend the lease.

In addition to the standard notice to the owner, make sure your leases require the tenant to notify the lender of any defaults in the lease and allow them additional time to cure the default, says Bosch.

Limit owner liability for breaches. When a lender or other third party steps in as the new owner after foreclosure, it does not want to assume any responsibility for the actions or omissions of the previous owner. Your lease should specifically provide that any lender or new owner that steps in after foreclosure is not liable to the tenants or any other third parties for breaches of the lease by the previous owner, says Bosch. In addition, the owner's liability should be limited to its interest in the property in all cases—lenders will not want to assume leases that include the possibility for personal liability.

Restrict use of tenant improvement allowances. This area draws a lot of attention from lenders, as the unreimbursed costs involved are usually substantial. Tenant improvement (T.I.) allowance funds are the funds provided by the owner to the tenant to build out the tenant's space beyond standard improvements typically offered by the developer.

Lenders like to see provisions in the lease that restrict the use of T.I. allowance funds to items or improvements that will increase the value of the building or center, says Bosch. Also, lenders favor provisions that prohibit the tenant from making any alterations to the property that might decrease the value of the property, result in structural damage to the premises, or simply would be difficult to be removed in order to prepare the premises for a future tenant, she adds.

Insider Sources

Matthew C. Alshouse, Esq.: Associate, Baker & McKenzie LLP, One Prudential Plaza, 130 E. Randolph Dr., Chicago, IL 60601.

Pilar L. Bosch, Esq.: Partner, Baker & McKenzie LLP, Mellon Financial Center, 1111 Brickell Ave., Ste. 1700, Miami, FL 33131; (305) 789-8900.