Subject-To Conditions

Subject-To Conditions in Commercial Mortgages

In the field of commercial real estate finance, Subject-To Conditions (often referred to as conditions precedent) are specific requirements, contingencies, or benchmarks that must be satisfied by the borrower before a lender is legally obligated to fund a loan. When a lender issues a commitment letter or a term sheet, it is typically "subject to" the successful completion of due diligence and the verification of certain facts regarding the property and the borrower.

These conditions serve as a risk management tool for the lender, ensuring that the asset’s value, the borrower’s financial standing, and the legal status of the property align with the assumptions made during the initial underwriting process. If these conditions are not met to the lender's satisfaction, the lender reserves the right to alter the loan terms or decline funding entirely.

The following are common Subject-To Conditions found in commercial mortgage agreements:

• Satisfactory Appraisal: The loan is almost always subject to an independent, third-party appraisal that confirms the Fair Market Value of the property. If the appraised value comes in lower than expected, the lender may reduce the loan amount to maintain a specific Loan-to-Value (LTV) ratio.
• Environmental Reports (Phase I and II): Lenders require a Phase I Environmental Site Assessment to ensure there are no hazardous substances or contamination issues on the property. If concerns are flagged, a Phase II (involving soil or water sampling) may become a condition for closing.
• Property Condition Assessment (PCA): For existing structures, lenders often require an engineering report to identify any immediate repairs or deferred maintenance. The loan may be subject to the borrower establishing a capital expenditure reserve to fund these repairs.
• Title Insurance and Survey: The borrower must provide a clean title commitment showing no unexpected liens, encumbrances, or legal disputes. A current land survey is also required to verify property boundaries and ensure no encroachments exist.
• Lease Review and Estoppel Certificates: For income-producing properties, the lender will review all existing tenant leases. A common condition is the delivery of Tenant Estoppel Certificates, which are signed statements from tenants confirming the terms of their lease and that the landlord is not in default.
• Financial Verification: The commitment is usually subject to a final review of the borrower’s and guarantors' updated financial statements, tax returns, and Know Your Customer (KYC) documentation to prevent fraud and money laundering.
• Legal Opinion and Documentation: Lenders require their legal counsel to review all entity documents (such as Operating Agreements or Bylaws) to ensure the borrower has the legal authority to enter into the mortgage contract.
• Insurance Requirements: The borrower must provide proof of adequate insurance coverage, including property, liability, and often rent loss insurance, naming the lender as the Loss Payee or Additional Insured.

Failure to satisfy these conditions within the specified lock-in period or before the closing date can result in the expiration of the loan commitment. Because many of these conditions involve third-party professionals (appraisers, engineers, and lawyers), the "Subject-To" phase is often the most time-sensitive and complex portion of the commercial mortgage process.