Commercial Real Estate Loans – Due Diligence 101

Real Esate Due DiligenceLenders making commercial real estate loans in the Chicago market face harsh competition in terms and pricing and often have to make significant concessions to borrowers. Given the highly competitive market, loan officers may end up focusing on doing whatever it takes to get the loan in the door, and may inadvertently overlook pertinent details in connection with the borrower, the guarantor or the collateral.

This oversight may not be discovered until after the loan has been approved by the lender and a loan commitment letter has been provided to a borrower, which could leave the lender in a precarious position. In order to reduce the lender’s risk of discovering problems after the loan has been approved, lenders should take steps to obtain and review potential borrowers’ due diligence documents before loans are approved.

At a minimum, lenders should know the following information:

Is the borrower an individual, a trust, a partnership, a limited liability company or a corporation?

  • Who are the trustees, beneficiaries, partners (limited or general), members, managers, officers or directors of the borrower?
  • If borrower is not an individual, has the borrower provided copies of the trust agreement, partnership agreement, operating agreement or by-laws for each layer of the borrower entity?
  • Has lender run credit checks and UCC/judgment/pending litigation/bankruptcy and tax lien searches on the borrower and guarantor?
  • What financial obligations do the borrower and/or guarantor have to other lenders?

How is title to the real estate collateral held, and what is the intended use of the real estate collateral?

  • What property interest does borrower own or intend to acquire?
  • What is the borrower’s intended use of the real estate collateral?
  • Are there any physical limitations to borrower’s intended use of the real estate collateral?
  • Are there any legal restrictions to borrower’s intended use of the real estate collateral?
  • What is the estimated value of the real estate collateral?
  • Are there encroachments, encumbrances, environmental issues that affect the use or value of the real estate collateral?
  • Are there any leases in effect, and if so, what are the terms of those leases?
  • Does the income from the real estate collateral cover the monthly debt service?

Does the borrower plan construction with all or a portion of the loan proceeds?

  • What is the estimated value of the real estate collateral post-improvements?
  • How will loan proceeds be disbursed (i.e., through a construction escrow at a title company, or directly to the general contractor and subcontractors in exchange for lien waivers)?
  • Does the borrower have a budget for the proposed construction?
  • Has the borrower entered into any contract with an architect or general contractor regarding the proposed construction?

What type of additional collateral is the borrower and/or guarantor offering as security for the loan?

  • Business accounts, operating accounts, accounts receivables, stock certificates, etc.?
  • Who owns title to the additional collateral? Is it owned jointly with another person or entity?
  • Does the borrower or guarantor actually own the additional collateral or does the borrower or guarantor merely lease the collateral?
  • How will the lender properly secure and perfect its interest in the collateral?

When lenders take the time to ask questions and obtain documentation regarding the borrower, the guarantors and the proposed collateral prior to approving commercial financing, this puts lenders in the best position to evaluate the proposed transaction and to properly secure the collateral for the loan.

“An ounce of prevention is worth a pound of cure.” -Benjamin Franklin

This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

Finance-Lawyer-Wendy-ReutebuchWendy M. Reutebuch | Real Estate, Real Estate Finance and Creditors’ Rights

Wendy represents clients in both Illinois and Wisconsin in a wide variety of commercial real estate and real estate finance transactions. In addition to handling acquisitions, dispositions and leases, Wendy also advises lenders on loan transactions, loan workouts, loan restructurings, forbearance and pre-foreclosure matters.  If you need assistance with a related matter, contact Wendy.