Underwriting Tip: Commercial Conundrum

When a lender provides financing for the acquisition of commercial property or in a refinance transaction, they often request removal of the general parties in possession and tenant exceptions from the loan policy, despite the fact there are tenants in possession of the property pursuant to unrecorded leases. What should you do?

Acquire a Lease

Begin by acquiring a copy of each lease affecting the subject property. Verify that each lease contains a provision stating that the lease is automatically subordinate to any existing or future mortgage without any additional documentation or action of the parties. This is known as an automatic subordination clause. Often, especially in a refinance transaction, if the lease does not contain an automatic subordination clause, a prior lender has foreseen the issue and acquired and/or recorded an SNDA agreement (Subordination, Nondisturbance and Attornment Agreement).

If the lease contains a subordination clause, you will need to determine if the subordination is automatic or requires additional action. Note that with one exception, reliance on an automatic subordination agreement is a hazardous risk that requires underwriter approval.^[1]There are times when a lease will contain the subordination clause, but it will not be automatic, meaning the lease requires additional action, such as the lender and tenant executing and/or recording a subordination agreement.

Is the Lease Subordinate?

Many times, the lease will be silent as to whether it is subordinate to future mortgages. In other words, the lease does not contain a subordination clause, automatic or otherwise. In that situation, it may be impractical or too time-consuming for the owner to obtain a subordination agreement from each tenant, yet the lender will not accept the general parties in possession or tenant exception.

In such a case, there are two alternate exceptions that most lenders will accept. The loan policy can contain an exception for either: (i) tenants as tenants only pursuant to unrecorded leases with no rights of first refusal or options to purchase, or (ii) rights of tenants as tenants only pursuant to unrecorded leases with no rights of first refusal or options to purchase who are identified on an exhibit attached to the policy. In both situations, the agent will need to review the leases to confirm that none of the tenants have a right to purchase the property or right of first refusal. If using the latter language, the agent must obtain from the owner immediately prior to closing a rent roll identifying all the tenants along with an affidavit attesting to the accuracy of the rent roll and representing that none of those parties listed have any rights of first refusal or options to purchase the subject parcel(s).

As always, if you have questions on how to address the tenant exception in a loan policy, reach out to your local underwriter, who will be happy to provide the necessary guidance.

^[1]Underwriter approval is not required if relying on an automatic subordination agreement in a residential lease involving an apartment complex.

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