When considering your debt options for a commercial real estate deal, you have two main options:
- Secure new debt
- Assume the existing debt
If the owner pre-negotiated an assumption right into their loan documents, once they go to sell the property, potential buyers have the option to assume the existing the loan. That is, the existing loan is transferred from the current borrower to the new borrower at the same terms.
When you are analyzing an on-market deal, there is typically a section in the offering memorandum that states whether the loan is assumable.
When you are analyzing an off-market deal, you will need to ask the owner if the current debt is assumable. There aren’t absolute pros and cons of an assumable loan because the benefits and drawbacks vary based on the buyer’s financials and experience, the terms of the existing loan, the type of existing loan, and the market conditions. So, instead. Let’s focus on the potential pros and cons of assuming a loan.
Potential Pros of an Assumable Commercial Real Estate Loan
Time Savings: Loan assumptions can be approved in as little as 30 days (maybe even sooner) whereas a new loan may take a few months to complete due to the extra documentation required.
Money Savings: Because the loan assumption process may be shorter and requires less documentation, the costs incurred via lender fees are typically lower than the costs incurred from securing a new loan.
Better Terms: The buyer has the opportunity to receive better loan terms – a lower interest rate, fixed interest rate, longer term, etc. – than they would of if they secured a new loan.
Lower Down Payment: When a buyer assumes a loan, the down payment is equal to the difference between the amount owed by the debt and the sales price (i.e., the equity). If the owner doesn’t have a lot of equity in the deal, the down payment may be lower than the down payment on a new loan.
More Attractive Deal: Because of the aforementioned pros of the assumable loan, a seller may attract more buyers as well as sell the property faster.
Potential Cons of an Assumable Commercial Real Estate Loan
Longer Approval Process: if the current loan is overly complicated, the loan approval process can take longer than the process of securing a new loan.
One Lender: The buyer who is assuming the loan is forced to work with the lender that holds the existing debt.
Higher Down Payment: If the owner has a lot of equity in the deal, the down payment may be higher than the down payment of a new loan.
Worse Terms: if the terms of the existing loan aren’t as favorable as the current market terms, the debt terms could be worse than the terms of a new loan.
Won’t Qualify for the Assumption: Lenders have broad discretion when qualifying a buyer for an assumable loan. For example, they will want the buyer’s financials and experience to be similar to those of the current owner. So, the buyer may not qualify for the assumption. Because of these potential cons, it is important to have financing contingencies in place in your contract and have a few lenders on back-up in case you don’t qualify for the assumption.