Zoning compliance of increasing importance to CMBS lenders.
As the CMBS industry matures, evidence of zoning compliance continues to stand out on the closing checklist as one due diligence item that defies standardization. Meanwhile, the importance of zoning compliance only escalates in the CMBS arena among rating agencies, lenders, borrowers, developers, owners, closing attorneys and title insurers.
Not too much earlier in the decade, "zoning issue" was all but an oxymoron, and a zoning problem was hardly capable of holding up the funding of a mortgage loan. Today, the lack of clear and sufficient evidence that a lender's collateral complies with applicable zoning ordinances can - and will - hang up a closing indefinitely, and is certainly capable of adding delay to otherwise straightforward transactions.
As the market matures, so too do the expectations and demands of both the rating agencies and the institutional B-piece buyers. "No zoning, no closing" has increasingly become that mantra of many of today's CMBS lenders, and more recently with respect to multifamily as well as commercial properties.
As a consequence, the CMBS marketplace his seen an emergence of groups such as National Zoning Group, LLC, which specialize in quickly procuring satisfactory zoning letters from the appropriate municipalities on an expedited basis. A property-specific and rating agency-sensitive zoning report is then prepared, determining whether or not collateral is in compliance with the applicable zoning.
There is still no CMBS industry consensus as to who should be held responsible for procuring evidence of zoning compliance - borrower, lender or lender's counsel. "There is still a gray area," says David Taplitz, Esq. of National Zoning Group, "as to who is responsible for zoning, and many of the major CMBS lenders have been happy to let us fill the void."
Even if sophisticated borrowers commence the zoning clue diligence very early in the due diligence period, results will be mixed with each municipality.
For instance, some municipalities issue compliance letters on the spot, while others take weeks. Some refuse to issue any statement whatsoever with respect to zoning. If they do, they either say volumes or, more likely than not, nothing at all with respect to zoning.
Some municipalities - particularly those in more rural jurisdictions - are altogether unfamiliar with the concept of a zoning letter, and approach the requesting party with caution, at best. Other municipalities - particularly those with experience issuing zoning letters - are quick to catch on to the value of a properly certified and straightforward zoning letter, and so charge handsomely for their toils.
Thus, unsophisticated borrowers rarely produce satisfactory zoning letters, and the result usually warrants a costly and time-consuming review by the lender and/or lender's counsel in any case.
Some lenders opt to keep the laborious, albeit straightforward, process of procuring zoning letters in-house, passing the cost directly to the borrower. Often the lender's outside counsel will outsource the zoning due diligence themselves, passing the cost through to the lender as a legal disbursement, who, in turn, again pass it through to the borrower.
Specialty zoning outfits such as National Zoning Group Facilitate the lender's decision (or borrower or closing counsel, as the case may be) to outsource zoning due diligence. Such specialization, they argue, brings to the closing table an efficiency that ultimately saves all parties to the transaction time, effort and money. The mere uniformity in the presentation of zoning compliance such reports bring to any group or pool of loans might prove valuable in the secondary market.
Since evidence of zoning compliance is the first uncommon denominator in an otherwise uniform group of loans, it is thus subject to heightened scrutiny should the agencies shine a light on any loan or pool of loans.
As the CMBS loan programs become streamlined, the only variations on an otherwise standard due diligence checklist tend to be zoning related.
For instance, a closing attorney's decision as to whether to entitle the security instrument a mortgage, deed of trust or deed to secure debt would be determined by the state in which the security instrument is to be filed. Also, the decision to insert state-specific provisions to into the loan documentation is similarly determined on a state-to-state basis, allowing uniformity of a lender's set of loan documentation at least on the state level.
Uniquely, zoning ordinances vary not only from state to state, but from municipality to municipality. Their nuances and complexities are as ubiquitous as are the countless zoning offices across the country which uphold them, making it all but impossible to standardize CMBS zoning due diligence on any level.
Save for perhaps a survey (and often surveys are already complete, if not updated, once the borrower comes to the table), zoning due diligence requires more lead time than any other item on the due diligence checklist. Zoning endorsements, if available from the title company, tend to carry hefty premiums, and can require as much time as the issuance of a zoning letter. In fact, many title policy issuers will require precisely the same zoning letter and/or evidence of zoning compliance from the municipality to issue such an endorsement as the lender would have otherwise required. This puts the lender in the same position had it sought the zoning letter initially, less a bit more time and a lot more money.
The evolution and increasing uniformity of loan program offered by lenders in the CMBS markets has unveiled the irregularities in the treatment of zoning issues from one municipality to the next. This applies not only with respect to collateral located throughout the countless municipalities across the U.S., but also in lending programs with exposure in Canada and Mexico.
As with most other CMBS due diligence matters, zoning compliance, per se, is usually not an issue. Rather, the problem increasingly confronted by the lenders is the ability to properly demonstrate zoning compliance efficiently, effectively and uniformly. The methods of procuring comfort that their collateral complies with applicable zoning ordinances still varies widely from lender to lender.
Zoning compliance and uniform methods efficiently demonstrating such compliance will only grow in importance and continue to add immeasurable value to any loan or pool of loans, if only to save the lender time and trouble down the long, tumultuous road to Securitization Land.
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|Title Annotation:||real estate; First Quarter Review|
|Author:||Lasala, John P.|
|Publication:||Real Estate Weekly|
|Date:||Apr 7, 1999|
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