Negotiating Reserve Provisions in Real Estate Loan Transactions

Reserve provisions are of particular interest to the borrower because of their impact on loan proceeds disbursed at closing and the borrower’s autonomy in managing its cash flow throughout the loan term. Reserves for taxes and insurance, capital expenditures/replacement, tenant improvements, and lease commissions, FF&E (required for hotels) or excess cash are usually cast as monthly deposits. Immediate repair, environmental and earnout reserves are usually one-time deposits that are required at closing in response to issues uncovered by the lender in its property inspection or environmental report.

Borrowers want to minimize all of these reserves, and often contest the way in which they are calculated, the timing of deposits, who shall be entitled to interest on the reserve accounts, and the conditions under which funds are released. Counsel should understand how these reserves are underwritten by lenders, and the options that may be available to reduce the amounts required to be deposited into reserves (or the amount at which they should be capped) and streamline the conditions for release of funds to the borrower.

Listen as our panel of lender’s and loan servicer's counsel discuss the types of reserves—including tax and insurance, cap ex, tenant improvement/rollover, FF&E, excess cash and repair, and environmental reserves—and how those reserves might be funded and disbursed under the loan documents. The panel will also discuss the different types of earnout reserves and seasonality reserves (for hotels), and how letters of credit might be used in lieu of cash.

1. Monthly reserves
   1. Tax and insurance
   2. Capital expenditure/replacement
   3. Tenant improvement and leasing commisions
   4. FF&E
   5. Excess cash
2. Upfront reserves
   1. Immediate repairs
   2. Environmental
   3. Earnout
3. Seasonality reserves (hotel)
4. Points of negotiation—interest, triggers for deposits, caps, and conditions for release
5. Letter of credit as alternative to cash

The panel will review these and other key issues:

• Monthly reserves required for each property type, and how they are determined by the lender
• How the engineering report is used to determine the repair reserve
• When an environmental reserve is required, and how Phase I and Phase II reports are used to determine reserve conditions
• Standard points of negotiation on the foregoing reserves—interest, caps, triggers, conditions for release
• Use of letters of credit in lieu of cash reserves