My own hard money commercial mortgage company, Blackburne & Sons, recently made a very interesting commercial loan. We made one blanket private money loan against eleven rental houses in a small town in Ohio. When we put the loan out for sale to our private investors, the loan sold out in less than one hour. Our investors just scarffed it up. Yum!
Blackburne & Sons intends to make more such loans - blanket loans against a portfolios of free-and-clear rental houses. In fact, we made a blanket loan offer this week on 23 rental houses in Indianapolis.
Sooner of later these investors / speculators are going to want to start selling off these houses. How do you sell off a single house when that house is subject to one blanket mortgage covering 22 other houses? The answer is a partial release clause.
A partial release clause is an addendum to a note and mortgage that says that the lender will release one of the parcels upon a paydown on the mortgage of a certain dollar amount. Here is an example of a partial release clause that we included in our recent offer on the 23 homes:
"PARTIAL RELEASE: Finished lots (or individual homes) can be sold off and released individually upon the payment of a Partial Release Fee equal to a 1.5 percent of the amount prepaid and a pay-down of the principal equal to the higher of 87% of the sales price or 125% of the loan value assigned to each lot, home, unit, or parcel."
So how much does the borrower have to pay down his loan to have a property or unit a released? The lender will assign a loan value to each property, home, or unit. For example:
Unit A .... $42,000
Unit B .... $26,000
Unit C .... $84,000
Now let's suppose the owner finds a buyer for Unit A willing to pay $63,000. The lender has assigned a loan value to that particular house (Unit A) of $42,000. If the lender has a 125% partial release provision, this means that to release this particular house the borrower must pay down the blanket loan by 125% of $42,000 or $52,500.
Different lenders will have different partial release formulas. For example, one lender might only have a 115% partial release requirement. This means that to sell off the first house (Unit A), the owner would only have to pay down the blanket loan by 115% of $42,000 or $48,300.
Why do commercial lenders even require a partial release formula? Why not just prorate the loan among the various units and just release each unit for a paydown equal to the loan value assigned to that unit; e.g. release Unit A for a $42,000 paydown?
The answer is that the appraiser assigning a loan value to each unit might be wrong with his estimates. Maybe Units A, B, and C are great units, but the rest of the units are perceived as stinky by the marketplace. Maybe Units D and E lack a view of the ocean, and Units F and G overlook a landfill (a garbage dump).
Without a conservative partial release formula, Units A, B, and C might sell for $200,000 each and would be quickly released. This might leave the lender with a $200,000 remaining loan balance blanketing four units that collectively are worth only $140,000. Yikes!
A conservative partial release formula allows the lender to effectively "make a profit" each time a unit is sold. Each time a unit is sold the blanket loan is paid down disproportionately, leaving the lender even more secure than he was before. This prevents the lender from being stuck with a lot of lemons.