Capital Markets: Third-party reports are important

Lenders rely on objective outside assessments when underwriting MOB deals

By Erik Tellefson

Third-party reports can play a critical role in medical office building (MOB) transactions. These are reports on the building and the site and are required and relied upon by lenders, and often by buyers. Third-party reports are performed by third parties (hence the name) who are unrelated to the transaction and are often national providers.

Lenders typically rely on third-party reports to confirm that the property is in good condition and to identify any necessary spending, both up front and ongoing. The reports can attest that the environmental aspects of the property are acceptable and that the market value of the asset is in line with the lender’s underwriting and, in the case of an acquisition, with the borrower’s purchase price. These reports include:

1. Property condition report. This report gives an indication of the asset’s condition and the amounts necessary to spend on the property. Two important considerations include:

  • Immediate repairs – if these are significant enough, or if there is an Americans With Disabilities Act (ADA) compliance issue, these may be referenced in the loan agreement as a condition to close and/or as a requirement to complete.
  • Potential deferred maintenance. This is another aspect of the property condition report – potential deferred maintenance costs are compared against the capital expenditure budget at the facility to ensure that such costs can be covered.

2. Environmental report. This report describes the environmental condition of the property – including below-ground aspects such as storage tanks — and is typically referenced in the loan proposal, with the requirement to close being an acceptable environmental status or a commitment to perform required remediation.

3. Appraisal report – This report identifies the market value of the asset, usually by considering a number of factors including the asset’s price, the income it generates and the costs involved. The appraisal is primarily used for identifying the “as is” and “as stabilized” value of an asset, although it is often used for comparisons of underwriting points as well.

Third-party reports are an important consideration in lending. Lenders often write third-party report outcomes and/or acknowledgements into both their loan proposals and loan documents. For example, in a property condition Report, implementation of immediate repairs can be a condition to close, or a requirement for completion of the transaction.

Similarly, an environmental report that is satisfactory to the lender – or remediation of issues pointed out in such a report – may be a requirement to close. In the appraisal, the loan amount may be subject to a loan to value test, using the appraisal as the baseline number for value.

Buyers also look at third-party reports for an opinion on the condition of the asset, the appraiser’s underwriting and idea of value, and the environmental condition of the site. These concerns are similar to lenders’ interests, but considering the buyer’s equity as the first potential loss in terms of the capital stack, the environmental and property condition reports are especially important.

Given the reliance of lenders and often borrowers on third-party reports and their extensive use in loan proposals and loan documents, it is not surprising that these reports are an important consideration in MOB deals. Lenders that can structure their transactions to quickly analyze, act upon and approve such reports are frequently able to close loans more quickly and efficiently than other lenders can.

Erik Tellefson ColorErik Tellefson is Managing Director with Capital One Healthcare and leads medical office and medical property lending. He has 18 years of experience in commercial real estate finance, including 13 years focused on healthcare, and works with clients to finance acquisitions, refinance existing debt, support working capital needs and fund growth initiatives.

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