Assignment & Assumption of the Seller’s Loan
For a commercial real estate investor considering a purchase the issue of mortgage tax on an acquisition demands sober consideration. In New York City the mortgage tax on any commercial property over $500,000 dollars is 2.8% of the loan amount. A significant sum when considering an investment in the multi-million dollar range.
Consequently over the course of the years, savvy investors have relied on the ability to assume the seller’s mortgage, take a gap loan and consolidate both loans into one via a Consolidation, Modification and Extension Agreement. In this manner, the purchaser is only responsible for paying the 2.8% on the “gap loan,” or the additional principal, over and beyond the principal assumed on the seller’s mortgage. For example, if a property is purchased for $2.5 million dollars, and the seller has an existing mortgage balance of $1.5 million dollars on the property, and that loan is assumable, the purchaser can negotiate with the seller’s lender for the additional financing or gap loan up to 70% to 90% of the value of the property. [The loan to value would be determined by the lender and the applicable loan program]. Accordingly the purchaser would be required to bring to the table at least 10% to 30% of the purchase price.
This strategy if available and agreed to by all parties, affords a commercial real estate investor the ability to acquire a property at a significant savings in the mortgage tax. Additionally, it allows the seller to more readily and successfully consummate the transaction, while allowing the seller’s lender to benefit from retaining a performing loan, increasing the principal owed and encumbering the property for the full value of the loan as collateral.
In today’s real estate market, this strategy can be even more valuable to purchasers, sellers and lenders. For example, if the purchase price of a property is $2.5 million but the seller’s mortgage principal is $3 million, the parties can negotiate various options in order to successfully consummate the transaction.
Option One: Pay-down the Principal-if the seller’s lender is inclined to allow the purchaser to assume the mortgage, it can require the seller to pay-down the mortgage up to the amount of the balance to be assumed by the purchaser. This is contingent on the seller’s ability to pay down the principal owed which, if distressed, would probably rule out this option.
Option Two: Split & Spreader Mortgage-the parties can negotiate with the seller’s lender to split the mortgage into A and B parts. Mortgage A could be $1.75 million dollars, continue to encumber the property and be assumed by the purchaser. Then the lender would release the seller’s obligation on Mortgage A and Mortgage B could be spread over other properties the seller owns.
Option Three: A Shortsale- the seller’s lender agrees to sell the property to the purchaser for less than the principal owed on the mortgage. Seller has no further obligation. Lender writes off loss and loses out on a possible performing loan. Purchaser benefits from a discounted purchase price.
Out of all three options, Option Two affords all parties: the distressed seller, burdened lender and savvy investor a means to benefit monetarily –whether it by reducing his indebtedness, retaining a performing loan, or savings in both the price and mortgage tax of the transaction.
In a climate where a significant number of commercial mortgages are expected to term, owners are unable or unwilling to subsidize their properties with their own capital, and lenders await overwhelming defaults and delinquencies, Option Two offers a vehicle to mitigate an avalanche of potential losses.
Consolidation, Modification & Extension Agreements (CEMAs) in Focus
Wherever there is an assumption of a loan, a Consolidation, Modification and Extension Agreement needs to be in place to complete the purchase transaction. Within the assumption vehicle, the new borrower or purchaser, can either assume only the outstanding principal on the seller’s mortgage, or borrow additional monies to leverage the purchase further. Further there may be instances where the seller’s lender assigns the loan to the new borrower’s lender to consummate the assumption.
If the borrower only assumes the principal outstanding, there is no mortgage tax consequence in the transaction. Nonetheless, a Modification and Extension Agreement would be needed to reflect the new borrower, perhaps a new lender, and extension of the terms of the mortgage. However, when the purchaser borrows additional sums, beyond the assumable principal, a Consolidation, Modification and Extension Agreement would be required. This document in effect consolidates the assumable principal with the additional or “gap” monies borrowed. In this latter instance, the borrower would be responsible for paying the 2.8% mortgage tax on “gap” loan but benefit from no tax implications on the principal assumed.
In negotiations with the seller, the seller’s lender and your lender the following issues are important to keep in mind:
- Incoming lender (Your/Purchaser’s lender): Its interests are to maintain or establish a profitable relationship with you by offering you more competitive terms on the loan.
- Outgoing lender (Seller’s lender): In considering an Assignment and Assumption transaction, the outgoing lender might place the issue of the mortgage tax savings on the principal assigned to the new lender and assumed by the new borrower on the table for negotiations.
In situation B it is critical to consult with your real estate attorney in order to effectively negotiate this issue and ensure the dollar savings you anticipate from not having to pay the mortgage tax on the principal transferred.
[Information derived from interview with Panel Expert: Cynthia R. Neiditch, V.P., Counsel Abstract Inc.]
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