How to Navigate Loan Assumptions in Real Estate Acquisitions

In 2023, we witnessed an unprecedented rise in interest rates, which caused many real estate investors to consider assuming a seller’s existing debt with low fixed interest rates when acquiring real estate property. As we look ahead to 2024, we expect real estate investors sitting on the sidelines to continue to seek out transactions with assumable debt to deploy capital.

At the outset of any transaction involving the assumption of existing debt, it is critical for buyers to be aware of the unique considerations in such transactions, including negotiation tactics for the purchase and sale agreement (and related transaction documents) and diligence best practices with respect to the existing loan.

Purchase and Sale Agreement Considerations

The Seller’s Representations and Warranties Regarding Existing Debt

When negotiating a purchase and sale agreement involving a loan assumption, the buyer should insist that the seller provide a schedule of the existing loan documents and reserve amounts. The buyer will rely on the schedule of loan documents and copies of the loan documents delivered by the seller to adequately diligence the terms and conditions of the loan. Accordingly, the buyer must also insist that the seller make certain representations and warranties regarding its existing loan, including:

• The loan schedule provided is accurate, correct, and complete.
• The loan schedule includes the current reserve amounts.
• The seller has delivered accurate, correct, and complete copies of all the existing loan documents.
• There are no defaults under any of the existing loan documents.
• All required principal and interest payments due and payable have been paid.

Lender’s Approval of the Loan Assumption

Additionally, the purchase and sale agreement should explicitly state that the acquisition is contingent upon the lender’s approval of the buyer’s assumption of the underlying loan. The buyer should also require that the lender’s approval of the loan assumption include:

• Consent to the buyer’s acquisition of the property.
• Consent to the loan assumption without any modifications to the material and/or economic terms of the loan.
• Approval of the buyer’s permitted transfers and any other requested modifications to the existing loan documents that relate to items personal to the seller or the buyer.
• Release of the seller and the existing guarantor (including any guaranties) with respect to the repayment of the existing loan.
• Release of the seller and the existing guarantor (including any guaranties) from any liability for acts or other matters first occurring on and/or after the acquisition’s closing date, with the buyer (and its affiliates) only liable for any guarantor liability under the existing loan documents for acts or other matters first occurring on and/or after the acquisition’s closing date, provided that some lenders may treat environmental liabilities and “bad boy acts” differently due to the nature of proving when such matters first occurred.

The lender’s approval of the loan assumption should not modify the existing guaranties or disclose the existence of any default under the existing loan documents.

Loan Assumption Timeframe

The purchase and sale agreement should provide that the buyer will use commercially reasonable efforts to obtain assumption approval within 90-120 days of the effective date of the purchase and sale agreement. If the buyer does not obtain assumption approval within the designated time frame, the buyer should have the right to terminate the agreement (or, at its election, extend the time period for approval by a short period of time).

Assumption Fees and Other Costs

The buyer is typically responsible for the assumption fees and all other fees mandated by the lender in connection with the assumption. Because transactions involving loan assumptions have a longer lead time to closing than the standard 30 days of due diligence and 30 days to close, it is important to pay particular attention to the seller’s operational covenants and casualty and condemnation provisions in the purchase and sale agreement. Additionally, if the seller defaults, the buyer should request reimbursement of all of the buyer’s costs associated with the loan assumption (including third-party reports, diligence costs, deposits, and buyer’s and lender’s legal fees).

Assignment of Reserves

The purchase and sale agreement should provide that the seller must assign all its rights, title, and interest to all reserves and accounts held by the lender and, at closing, the seller will receive a credit equal to such reserves so assigned. 

Survival Period for Loan Assumption Provisions

In the purchase and sale agreement, the seller’s covenants and obligations regarding the existing loan and the loan assumption should survive for the duration of the survival period if they relate to obligations arising prior to the closing date. If the buyer first discovers after closing that the seller breached any of these covenants or obligations before the closing date, the buyer should have all rights and remedies available at law or at equity.  

Diligence Best Practices When a Real Estate Acquisition Includes a Loan Assumption

It is essential for the buyer who is assuming the loan to understand the applicable borrower covenants (such as insurance and financial reporting), any net worth or liquidity covenants under the Guaranty, and the scope of the non-recourse carveouts. Lenders, especially insurance companies, generally believe that loan assumptions are not a time to renegotiate loan documents. However, lenders are often more amenable to modification requests that are personal to the buyer assuming the loan, such as permitted transfers. 

The buyer assuming a loan should also consider requesting a reinstatement of any one-time assumption right if it decides to sell the property down the road and a prospective buyer would like to again assume the existing debt.

Key Takeaways

Real estate acquisitions that involve loan assumptions are likely to continue for the foreseeable future. Loan assumption acquisitions present a unique opportunity for investors, provided they negotiate specific terms into the purchase and sale agreement (and related lender approval documents) and ensure adequate diligence of the loan documents before closing.