Bank-Owned Real Estate Approaches for Lenders and Builders Legal Considerations When Holding or Managing REO Properties
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THURSDAY, MARCH 8, 2012
Presenting a live 90-minute webinar with interactive Q&A
Ren R. Hayhurst, Partner, Bryan Cave, Irvine, Calif.
Don Neff, President, La Jolla Pacific, Ltd., Irvine, Calif.
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REO Properties: Legal & Risk Management Strategies for
Lenders and Purchasers
Don Neff, President/CEO LJP Construction Services March 8th, 2012
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Topic Overview…
• REO Trends 2009 to 2011 • BANKS: Who & What? • REO Asset Categories & Risks • PCARs & Due Diligence • Repositioning for Value-adds
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2012 Foreclosure Rate Heat Map
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Foreclosure Markets Ranked
2010 2012 • 1 Las Vegas/Paradise, NV 7.7% 4.1% • 2 Ft. Meyers/Cape Coral, FL 7.1% 2.0% • 3 Merced, CA 6.6% 1.8% • 4 Riverside/SB County, CA 5.9% 1.97%
• 96 Dallas/Ft Worth/Arlington, TX .76% .68% • 105 San Antonio, TX .68% .60% • 109 Houston/Baytown, TX .65% .69% • 125 Austin/Round Rock, TX .58% .57% • 154 El Paso, TX .41% .19%
• 199 Tri-Cities, WA .08% .90% • 200 Tuscaloosa, AL .08% .14% • 201 Lincoln, NE .03% .18% • 202 Utica/Rome, NY .02% .03% • 203 Burlington/So. Burl., VT .01% .04%
USA 2010 Average = 1.2% (1 out of 84 homes)
Source: RealtyTrac Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2010 Housing Transactions – Dallas County
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2012 Housing Transactions – Dallas County
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2010 Housing Transactions – Harris & Travis Counties
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2012 Housing Transactions – Harris & Travis Counties
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Foreclosure Markets Ranked 2010 2012 • 1 Las Vegas/Paradise, NV 7.7% 4.1% • 2 Ft. Meyers/Cape Coral, FL 7.1% 2.0% • 3 Merced, CA 6.6% 1.8% • 4 Riverside/SB County, CA 5.9% 1.97%
• 9 Phoenix/Mesa/Scottsdale, AZ 4.44% 2.96% • 13 Reno/Sparks, NV 3.63% 1.79% • 20 San Diego, CA 2.67% .81% • 26 Los Angeles/Orange County, CA 2.41% .76% • 27 Prescott, AZ 2.41% NA
• 199 Tri-Cities, WA .08% .90% • 200 Tuscaloosa, AL .08% .14% • 201 Lincoln, NE .03% .18% • 202 Utica/Rome, NY .02% .03% • 203 Burlington/So. Burl., VT .01% .04%
USA 2010 Average = 1.2% (1 out of 84 homes)
Source: RealtyTrac Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2010 Housing Transactions – Las Vegas Market
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2012 Housing Transactions – Las Vegas Market
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2010 Housing Transactions – Maricopa County Market
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2012 Housing Transactions – Maricopa County Market
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Foreclosure Markets Ranked 2010 2012 • 1 Las Vegas/Paradise, NV 7.7% 4.1% • 2 Ft. Meyers/Cape Coral, FL 7.1% 2.0% • 3 Merced, CA 6.6% 1.8% • 4 Riverside/SB County, CA 5.9% 1.97%
• 63 Kahalui/Wailuku, Maui 1.2% NA • 65 Hilo 1.1% NA • 72 Kapaa, Kauai 1.0% NA • 143 Honolulu 0.5% .31%
• 199 Tri-Cities, WA .08% .90% • 200 Tuscaloosa, AL .08% .14% • 201 Lincoln, NE .03% .18% • 202 Utica/Rome, NY .02% .03% • 203 Burlington/So. Burl., VT .01% .04%
USA 2010 Average = 1.2% (1 of 84)
Source: RealtyTrac Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2010 Housing Transaction Report – Ewa Beach, Honolulu, & Mililani
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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2012 Housing Transaction Report – Ewa Beach, Honolulu, & Mililani
Source: Real Estate Economics Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Banks: Who & What? • Small Banks
- FDIC Insured community banks and savings associations—about 7500 in total across the US - Measures of financial strength based upon “Bankability Composite Score” (per FDIC) - If less than 2% Capital Structure, banks were likely to be taken over in 30 days - FDIC is relaxing this requirement
- Some previously active through FDIC cost sharing—lots of “red tape” to comply; Banks are now opting for mergers and acquisitions w/o federal government intervention
• Large Banks
- Large Money Center Banks (Wells Fargo, BofA, US Bank, etc) - Continuing to be active with in-house REO teams managing assets and dispositions - Some have seen changes in portfolio mix, but have same staffing levels
- For example: residential developments, master-planned communities, condominium towers, commercial buildings, industrial, retail, mixed use projects
- Portfolio mix varies as a function of bank merger & acquisition activity - For example: some banks have been long in Southeastern US residential development markets, so have a larger portfolio to digest
• What are the banks acquiring?
- Product type--see 5 primary asset types (slides 25-26) - Location--location—location is so important for successful repositioning - Stage of completion is also critical--drives risk assessment (PCAR recommendations) - Asset conditions also drive risk assessment—and budget for remedial work
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Banks: Improving Financial Strength
- FDIC Insured Banks on “Watch List” are identified as being “very
poor” to “poor”…in financial strength) - “Watch List” banks decreased from 714 (3/31/11) to 624 (6/30/11)
to 562 (12/31/11)… -21.3% - Banks identified as being stronger financially rose over the same
periods from 3265 (3/31/11) to 3578 (6/30/11) to 3810 (12/31/11)… +16.7%
- The number of banks failing decreased from 40 in mid-2011 to 27 by end of 2011… - 32.5%
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Banks’ Regulatory Environment
• Regulatory framework FDIC/Healthy Bank 80/20 cost sharing split on loan losses… and
profit on the upside also (tool first implemented early 1990s)
• Distressed loans become Non-performing Assets • Non-performing Assets lead to either adversarial
foreclosure action or friendly “deed in lieu” of foreclosure • Shift from borrower to bank into single purpose LLCs per
property (Once FDIC approval is received) • Bankruptcy of borrower slows foreclosure process • Use of Court Receiver limits risk of CDL to bank
- THIS IS VERY IMPORTANT
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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FDIC Changing with the times
• 3 Temporary Regional Field Offices • Handling Asset Dispositions of failed banks
• Irvine, CA opened February 2009, closed January 2012 • Schaumburg, IL opened March 2010, closing Sept 2012 • Jacksonville, FL opened end of 2009, closing late 2013
• “DRR”-Dallas, TX • Division of Resolution and Receivership
• “FDIC”-Washington, D.C. (Headquarters) • Federal Deposit Insurance Corporation • Other regional offices throughout U.S.
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Banks’ REO Challenges
• Banks are not set up to handle real estate • Do not fully understand construction risks, liability,
insurance, and customer service/warranty obligations • Distressed assets either get “worked out” or folded into
REO portfolio • Banks must perform proper due diligence and figure out
what they have acquired in order to determine best disposition strategy
• Property Condition Assessment Reports are key - Three PCAR levels
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Property Condition Assessments
• “PCAR” Reports
- Level A - Used for all five asset types - Existing conditions analysis & photo records - Deferred maintenance & recommended repairs
- Level B (Report A +)
- Primarily used for partially finished lots, partially complete homes - Estimated costs to complete - Remaining lifecycle of components - Components include building interiors, exteriors & common areas
- Level C (Report B+)
- Used for large residential & commercial projects - ADA accessibility review - Life safety review - C of O & permits review - Code compliance review
Copyright 1995-2012 by La Jolla
Pacific, Ltd. All Rights Reserved.
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Three Disposition Strategies
• Preserve and hold asset - Mostly feasible for raw land, blue-topped lots, or finished lots - Avoids potential risk and maintenance issues with vertical
construction • Bulk sale to investors/builders
- Perhaps most risk-averse strategy - Banks may struggle with heavy discounts (insolvency)
• Build out and retail to consumer - Able to minimize short-term financial losses - Potential risk/liability issues with construction defect litigation
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Example Bank Portfolio of REO Assets
• Single family developments - 15 home completed subdivision—simple to sell—slide 27 - “Broken” master planned community—complex to sell--slide 29
- 5 merchant builders with separate model complexes - 60 completed and occupied homes - 35 partially completed homes (slabs to framing and dry-in) - 120 partially finished lots (with on-site infrastructure) - Regional infrastructure partially complete (eg, 1st lift of asphalt, backbone
power, recreation centers,… all financed with Mello Roos bonds) - Multiple banks involved (frustrated Asset Mgrs are “herding cats”) - Multiple HOAs, common areas partially complete (bonds exposed)
• Attached developments (3-4 story, wood-framed)-- slide 30 • Mid-rise/ high-rise projects (concrete/steel)--slide 31
- 2 empty 20+ story condo towers (rental conversion?)
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
29
Asset Types (Common Definitions)
• Raw land & paper lots - Approved tentative tract map or preliminary plat
• Blue-topped lots - Rough graded but with only basic infrastructure
• Finished lots - Water, sewer, storm drain, street improvements, power
• Partially completed homes - Foundations, framing complete, dried-in,
• Finished homes - Certificate of Occupancy, Notice of Substantial Completion
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
30 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved
31
Foreclosed Homes
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Vandalism at Foreclosed Homes
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Master-Planned Community Issues
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3. Open space (Fuel Mod area--HOA maintained)
2. Finished, occupied homes with Mello Roos bond financed infrastructure (merchant builders A & B)
1. Regional Community Park with recreational facilities (HOA maintained after turnover)
8. Finished lots, slopes (SWPPP protected?) “New” home designs by merchant builder E
7. Blue-topped lots (SWPPP protected?) “New” home designs by merchant builder D
6. Partially Built-footings & slabs (“OLD” design by merchant builder C)
5. Partially Built-houses rough framed (with “OLD” designs)
4. “OLD” model complex and partially built “dried-in” houses)
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Town Home/Condominium Project
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High Rise Towers
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Sample Residential REO Risks Paper LotsBlue Top
LotsFinished
Lots
Partially Completed
Homes
Finished Standing Inventory
1 Entitlement expiration2 City/county fees3 Unforeseen soils issues4 Insufficient soils compaction5 Environmental violations (SWPPP's)6 Hazardous materials on-site / illegal dumping7 Fall hazards / attractive nuisances8 Missing or damaged infrastructure9 Theft or vandalism
10 HOA litigation11 Homeowner litigation12 Water intrusion / weather barriers13 Foundation deficiencies14 Structural framing deficiencies15 Structural deficiencies16 Inadquate MEP systems17 Acoustical deficiencies (attached product)18 Green washing19 Statute of limitations liability - 10 year tail20 Deferred maintenance
REO Risks by Asset Category
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Risk by Assembly (& Other Issues)
• Soils issues • Concrete foundations • Structural framing • Weather barriers • MEP (mechanical, electrical & plumbing) • Acoustical (for attached product) • Attractive nuisances (maintenance, trespass, etc.) • Entitlement Issues (expiring permits, fees, etc.) • Title (liens, judgments, easements, etc.)
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
38 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Window Installations and Weathering Lumber
39 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Pre-Stucco Weather Barriers Protect the Framing
40 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Gypcrete Before Drywall with Sound Isolation
41 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Gypcrete After Drywall with Sound Isolation
42 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Felt Wrapped Waste at Plates (Condos vs Apts)
43 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Arrestors & Isolators (Condos vs Apts)
44 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Roof Mounted Mechanicals
45 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Two-tiered Isolators
46 Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
Fire Putty Pads at Plumbing/Electrical
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Post Construction Issues—Deferred Maintenance
• Homeowner Association Maintenance Manuals (HOAs). • Homeowner Resource Maintenance Guides (SFDs). • Videotaped turnover walks & commissioning interviews. • Review of CC&R language and maintenance disclosures • Annual, quarterly, monthly maintenance tracking and reporting. • Property/building assessment reports (PCARs).
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Examples of Deferred Maintenance
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Disclosures, Specs & Workmanship
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Due Diligence Source Docs
• Project management files* • Purchase contract files • Field construction files* • Homeowner lot files • Customer service files • Warranty service files • Insurance certificates • Lead bank underwriting documents • Government (plans, permits, bond & fee ltr)
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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“List of 50” Archive Docs (Examples)
• Project Mgmt Docs
- A/E plans and calcs - Conditions of approval - Bldg permits - Geo-technical reports - Final compaction tests - Precise grading plans - Sequence lists - Off-site/on-site contracts
• Field Construction docs
- Gov’t inspection reports - QA/QC reports - Homeowner walk-throughs - Superintendent daily logs - SWPPP compliance - Material samples used - Structural reports - RFIs/ASIs
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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Repositioning to Add Value
• Strategies Vary by Product Type & Completion Stage
- Post Construction (limited options): - For-Sale to Rental conversion
- During Construction (more options): - Re-phase for new product mix & smaller releases - Re-bid all trade-scopes by phase - Reduce specification level & re-bid again
- Pre-Construction (many options): - Value Engineer/Re-Design to simplify structures & wring out costs - Integrate green elements (increasing energy and water efficiency) - Re-map for increased density &/or land use changes - Map extensions to preserve value
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
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THANK YOU!
Don Neff, President/CEO [email protected] www.ljpltd.com
Copyright 1995-2012 by La Jolla Pacific, Ltd. All Rights Reserved.
REO Properties: Legal Strategies for Lenders and Purchasers
Ren Hayhurst (Irvine,CA) 949-223-7125; [email protected]
Overview of Note and REO Sales • Note Sales
– Acquire Debt, Not the Underlying Asset – Seller is the Lender, Not the Borrower/Debtor – Subject to Defects in Documentation, Title, etc. – Must Complete Foreclosure Process Before Assuming Control
of the Property – Know Your Enforcement Options
• REO Sales – Take Title to the Asset; Deal Directly with Owner – Must Wait for Remedies to be Completed – Uncertainty Pending Foreclosure
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Note Sale Issues • Abundant Product Still Available
– Wave of Commercial Loans At Maturity or In Default • Banks More Likely to Sell than Special Servicers Who Tend to
Foreclose
• Reasons for Lenders to Sell – Avoids time and expense of foreclosure – Avoids risk of being stuck with REO for lengthy period – Preferred Disposition Method for the FDIC
• FDIC sales can come with protections, such as: (i) Loss share agreements, and/or (ii) Use of the FDIC “super powers”
• Not preferred by FDIC once the note is sold to successor if there is a loss share agreement in place
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Note Sale Issues (Part 2) • Reasons for Investors to Purchase
– Can Often Get Better Pricing on Note Sales – Can Provide Greater Options By Transferring Ownership of
Entire Debt Package
• Obstacles – Purchaser must have the ability to deal with the foreclosure
process – Purchaser Assumes Bankruptcy/Foreclosure Risk
• Risk Sharing is Difficult to Negotiate – most sales are “as-is/where-is”
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Due Diligence Issues
• Due Diligence Challenges – Note Sales Require Due Diligence on:
• The Loan, • Bankruptcy risk, • Potential lender liability and/or defects in loan documentation or
administration, • Condition of Title, and • Condition of the Property.
– REO Sales Requires Standard Property Purchase and Sale Due Diligence:
• Condition of Title, and • Condition of the Property.
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Due Diligence – Note Sales
• Loan Issues – Must Understand Risk of:
• Borrower Bankruptcy, • Lender Liability Claims, • Defects in Loan Enforcement
• Title Issues – Must Understand Effect of Foreclosure On Title
• Eliminate Junior Liens • Effect on Development Rights?
• Property Due Diligence
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REO Sale Issues • Advantages Over Note Sales
– Title is Cleaned Up for Purchaser – Bankruptcy Risk Eliminated – Can Be Structured in a Manner More Familiar to Purchasers
• Requires No Special Expertise or Experience as Required for Note Sales • Obstacles
– Lenders Increasingly Reluctant to Take REO on Books • Glut of Residential REO on Lenders’ Books • Lose the ability to clean up title (relation back theory of title) • Difficult to structure in “broken” construction loans or deals with
subordinate debt – Long Delays for Buyers and Sellers – Borrower/Purchaser Concerns for the Lender
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Due Diligence – REO Sales
• Focus On Property – Title Report
• Which rights eliminated by foreclosure and which rights survive the sale
– Market Research • Effect of Foreclosure on Market • Tenant Issues – Co-Tenancy Clauses, Rent Reductions, Etc.
– Environmental Report – Effect of Judicial Foreclosure vs Non-Judicial Foreclosure on
Redemption Rights • Redemption rights very limited in most states and most common in
trust deed states
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Use of Special Purpose Entities • Often Used in Deed-in-Lieu Prior to or in REO Sales Following a
Foreclosure • Reasons for Forming SPE in Foreclosure
– Isolate Troubled Asset from the Rest of the Loan Portfolio/Pool • Who Controls the SPE
– Agent or Lead Bank – Special Servicer
• Sole member vs. Multiple Members
• Problems – Transfer of all Tranche/Syndication Interests into SPE – Partial Note Foreclosure Issues
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Alternative Transaction Options
• Alternatives to Foreclosure – Deed in Lieu of Foreclosure – Title Subject to Competing Liens and Other Defects
• DIL and then foreclosure strategy can be useful
• Consensual Foreclosure – Permits a Lender to “Clean Up” Title, And Can Speed Up the
Process
• Consensual Bankruptcy – Risk Of Competing Creditor Interference – 363 Sale has Broader Effect on Creditor Claims
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Common REO Issues- Regulatory Considerations • Holding Period
– Only Applies to Regulated Institutions – 5-Year Maximum – Regulatory Drive to Sell Within 12 months
• Appraisals – Valuation for Foreclosure/Bidding Strategy – Hold vs. Sale Considerations
• Property Inspection – Use, Repair and Maintenance Issues
• Environmental Audit – Foreclosure Review – Use, Repair and Maintenance Issues – Alternative Remedies – Personal Liability Under Indemnity
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Survey and Title Considerations
• Use of Prior Survey – Update or Re-Certify Survey – Alternatives – Title Company Products (Plotted Easement
Map, Etc.)
• Title Policy – Binder if Foreclosing Owner – New Title Policy for Purchaser
• Potential Problems – Easement, Setback and Parking Issues – Mechanics’ Liens, CC&R Assessments
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Survey and Title Considerations II: Emerging Title Issues • Creditor's Rights Issues
– Consideration for Upstream and Downstream Guarantors – Solvency Representations/Source of Equity
• Broken Priority – Financial Statements From Borrower/Guarantors – Signed Indemnity Agreement from Borrower/Guarantor – Construction loan agreement
• Cost Break Down and Loan Budget – Cash Deposit/Letter of Credit
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Land Use Considerations
• Entitlements – Unstarted Project – Beware of:
• Moratoriums, • Changes in Developments Plans, • Expiring Development Agreements, and • Replacement Bonds
• Rent Control – Typically Survive Foreclosure
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Successor Liability
• Leases – Review Liability Under SNDA:
• Past Defaults, • Defaults During Ownership, and • Post-Assignment Liability.
• HOA/CC&R Defaults and Assessments – Typically Do Not Survive Foreclosure
• Profit Participation/Marketing Fees – Controlled by Agreements and Subordinations
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Project Development Challenges
• Stepping Into Former Project – Bonds need to be replaced – Broken Subdivisions
• Gaining Control of the Declarant’s Rights – Expired Entitlements and Development
Agreement - Moratoriums – Fee Credit issues - Reimbursements?
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