FHA Deal Accelerators: How to Secure Buy-In From Secondary Lenders and Commercial Tenants

“Motivation is the art of getting people to do what you want them to do because they want to do it.”
— Dwight D. Eisenhower

Having led the Allies to victory over Hitler in World War II, our 34th president knew what he was talking about when it came to motivation. It’s fun to imagine how Ike might have deployed his wisdom on motivation if he’d ever had to gear up for a Section 223(f) closing. Which parties might have needed an extra nudge from the commander in chief to keep the deal marching forward? In other words, in the context of a typical HUD-insured closing, who is least motivated to get the note endorsed?

Surely not the lenders – their representatives are chomping at the bit to earn their fees and move on to the next deal.

Surely not the borrowers – their principals are eager to avoid extension fees and start enjoying lower monthly payments.

Surely not the attorney, surveyor or title company – they generally don’t get paid until the deal closes, and they won’t be retained in the future if they contribute to a closing delay.

You might be tempted to say HUD is the least motivated party. But I can assure you, having worked at the department for many years, that most of my former colleagues were driven to get loans closed. Some staff were inspired to help HUD fulfill its mission, while others pushed toward closing simply so they could clear some space on their desks.

Reflecting on my chief counsel days, there was one type of entity that consistently dragged its feet en route to endorsement: those that were required to subordinate their interests to the new mortgage. This category includes tenants under commercial leases and lenders whose debt survives the HUD-insured closing. Let’s call them the subordinates.

The subordinates are poorly motivated because, unlike just about everyone else involved in the deal, they don’t stand to benefit financially once the loan proceeds start to flow. To make matters worse, the subordinates are often the most neglected party to the HUD transaction. After all, they only sign one document, so it’s common for them to get lost in the flurry of activity leading up to closing. But make no mistake about it: The subordinates, neglected and unmotivated as they may be, are essential in the sense that closing can’t happen without their sign-off.

So, how do you keep these parties engaged? In the absence of economic motivation, commercial tenants and secondary lenders need to receive persistent requests for cooperation (or, shall we say, polite nagging) from borrowers and lenders. Here are some polite nagging techniques to try on your next HUD deal.

Start Early

Given the high likelihood of subordinates balking, it pays to get on their radar early. In fact, I’d suggest contacting them as soon as the firm commitment is issued and introducing them to HUD’s Subordination Agreement. Waiting until a week or two before closing to start the subordination conversation is a recipe for a bumpy and stressful ride to endorsement.

Compliment and Commiserate

When introducing subordinates to HUD’s Subordination Agreement, set the stage by letting them know upfront that getting modifications to the document will be an uphill battle. If your subordinate is a governmental entity, HUD’s Closing Guide provides a path for negotiating the Subordination Agreement, but going down that path is time-consuming. By contrast, the Subordination, Non-Disturbance and Attornment Agreement (SNDA) for commercial tenants is not an official HUD form and theoretically more open to negotiation. Nevertheless, I think it’s fair to say that HUD offices are generally uncomfortable straying from the sample SNDA.

Even after setting the stage, most subordinates, unwilling to go down without a fight, will propose at least a handful of tweaks to the HUD language. At that point, I’d recommend a response like this:

Thank you for your comments on the Subordination Agreement. I think many of your requested revisions are perfectly reasonable, and if we were in a conventional loan setting, I’d be inclined to accept most of them and move on. But in my experience, HUD almost always rejects requests for modifications. Would you be willing to reconsider and accept the language as-is?

Commiserating with subordinates over HUD’s lack of flexibility in this area – rather than arguing with them about whether their revisions are legally material – is more likely to get them to accept the standard language.

Show Them “Before-and-After” Pictures

In my conversations with subordinates, I find that many of them feel like they’re being railroaded into giving up all their rights. But in almost all cases, the subordinates will not, as a result of the HUD closing, lose their relative priority in the project’s overall financing structure. More likely than not, they are already subordinate to a mortgage. You are simply asking them to re-subordinate to a different mortgage. Their “before-and-after” pictures will look pretty much the same. Simply reminding them of this fact may get them to reconsider their initial opposition to subordination.

With Commercial Tenants, Check for Subordination Requirements in Their Leases

When responding to requests to subordinate, the most challenging commercial tenants will refuse to cooperate unless their demands are met. However, these tenants may overestimate their bargaining power. It’s not unusual for commercial leases to contain a provision like this: “Upon the request of Landlord, Tenant agrees to subordinate its rights under this lease to the lien of one more mortgages now or hereafter in effect . . . .” It’s worthwhile to check the underlying lease for similar language when dealing with especially obstinate commercial tenants. If you’re lucky, you’ll find such language, at which point you can remind the tenants that subordination is not optional.

The Bottom Line

When your HUD deal involves subordination, talking early, often and strategically with the least motivated parties can make the difference between a smooth closing and the dreaded last-minute scramble that leaves everyone with a bad flavor in their mouths.