Many property owners may wish to convert their existing buildings to condominium form of ownership, which allows them to sell individual units to buyers and generate income. However, if the property is subject to a mortgage loan, the owner will need to obtain the lender’s approval and comply with certain conditions and requirements to effectuate the conversion and amend the loan documents accordingly. This article will provide an overview of the typical documents and process that a lender can use to allow an existing borrower to convert its property to condominium and what steps the lender should take under the existing loan documents to amend them to allow for partial release of the lien of the mortgage from the condominium units at the time of each unit sale to pay back the loan.
Does the loan agreement allow the condominium conversion?
The first step for the lender is to review the existing loan agreement and mortgage documents to determine if they contain any provisions that address the possibility of a conversion to condominium and the lender’s rights and obligations in connection with such conversion. For example, the loan agreement may include a section titled “Condominium Conversion” that sets forth the conditions and requirements that the borrower must satisfy before the property can be converted to condominium ownership, such as obtaining the lender’s prior written consent, submitting a proposed declaration of condominium and other condominium documents for the lender’s approval, providing evidence of separate tax lots and insurance coverage for each unit, delivering opinions of counsel and certificates of no default, and typically paying or reimbursing the lender for all costs and expenses associated with the conversion.
Ensure the condominium documents do not impair the lender’s rights and remedies
The second step for the lender is to review the proposed declaration of condominium (the Declaration) and other condominium documents (including any condominium offering plan) that the borrower submits for approval. The Declaration is the legal instrument that creates the condominium regime and defines the rights and obligations of the unit owners and the condominium board. The Declaration must comply with the applicable state law governing condominiums, such as in New York, Article 9-B of the New York Real Property Law (the Condominium Act). New York is also one of the only states that treats the sale of condominiums as securities, so the lender must also ensure that the condominium documents comply with Article 23-A of the New York General Business Law (the Martin Act). The lender’s attorneys must also verify that the Declaration, condominium offering plan, and related documents have been accepted for filing by governmental and taxing authorities, such as the Department of Law in New York, or that the borrower has obtained a no action letter when required by applicable law.
In reviewing the condominium documents, the lender should ensure that they do not impair the lender’s rights or the lien of the mortgage and that the lender can still exercise its remedies in the event of a default by the borrower under the loan documents. As additional security and as a condition to granting its approval, the lender could demand that the borrower execute and deliver documentation to protect the lender’s interests more fully, such as a collateral assignment of the borrower’s rights under the condominium documents and conditional resignations of the condominium board members who have been appointed by the borrower.
Once the borrower is ready to record the Declaration and form the condominium regime, the existing blanket mortgage encumbering the base lot should be indexed against each newly created tax lot. In addition, the loan documents customarily provide that the lender must then sign and record a subordination agreement that acknowledges that the lien of the blanket mortgage is subordinate to the Declaration. The effect of that subordination is that the lender’s rights and remedies under the mortgage are limited to the individual units and the corresponding interests in the common elements.
Amend the loan documents to permit partial releases of units
The final step for the lender is to amend the loan documents to allow for partial release of the condominium units at the time of each individual sale to pay back the loan and set minimum release prices for the units. Upon or simultaneous with a unit sale, the borrower/seller will pay to the lender the minimum release price for that unit to reduce the outstanding loan amount, and the lender will execute and record a partial release of mortgage for that unit at its closing. However, any remaining portion of the mortgage will continue to attach to the units still owned by the borrower.
Mortgage splitters for condominium sales can save on New York’s hefty mortgage recording tax
For some condominium sales in New York, the existing mortgage against the unit is not discharged but rather is kept in effect and assigned to the buyer’s lender at closing. This is done to save on mortgage recording taxes and is a type of finance transaction known as a consolidation, extension, and modification agreement (CEMA) loan or a splitter loan. Due to New York’s high mortgage recording tax, the savings from a CEMA transaction can be significant when properly structured by an experienced attorney.
Best practices for lenders
By following these steps, the lender can allow an existing borrower to convert its property to condominium and amend the loan documents to allow for partial release of the condominium units at the time of sale to pay back the loan. The lender should consult with its legal counsel and review the relevant documents carefully to ensure that its rights and interests are protected, and that the conversion and the release of the units are done in compliance with all applicable laws and regulations including the Condominium Act and the Martin Act.
Many of our real estate lender and borrower clients considering financings involving condominium properties have requested our assistance with their condominium formation planning and the drafting of their loan documents for these financing transactions. Nixon Peabody’s Cooperatives & Condominiums and Real Estate Finance attorneys would be glad to help you structure future transactions, navigate loan requirements, and understand legal regulations in connection with condominium mortgages and conversions.