Apartment Loan Covenants: What a Syndication Promises the Lender After Closing
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Loan covenants are the promises a borrower makes to the lender for the life of an apartment loan. They fall into two groups: things the borrower must do (send financial reports, fund reserves, keep insurance, maintain the property, keep the borrowing company a single-purpose entity) and things it must not do without the lender's consent (transfer ownership, take on more debt, change the property manager, make major changes to the building). Some loans also include financial tests, such as a minimum debt service coverage ratio, that trigger a cash sweep or other remedies if missed. Breaking a covenant can lead to fees, cash management, recourse under a guaranty or, in serious cases, a default.
This post is part of our guide to real estate syndication. It lists the common covenants, what they require from the sponsor and why investors should care. Terms vary by lender and loan; the loan documents decide.
The common covenants
| Covenant | What it requires | How often |
|---|---|---|
| Financial reporting | Operating statements, rent rolls, annual financial statements, sometimes a budget | Often quarterly and yearly |
| Reserves | Deposits for taxes, insurance and replacement reserves into lender-held accounts | Usually monthly |
| Insurance | Coverage types and amounts the lender sets, with the lender named | Continuous; certificates at renewal |
| Maintenance | Keep the property in good repair; complete required repairs by deadlines | Continuous |
| Single-purpose entity | The borrower owns only this property and keeps separate books and accounts | Continuous |
| Transfers | No change of ownership or control without consent, beyond allowed transfers | On any transfer |
| Additional debt | No other loans secured by the property, and often none at the borrower level | Continuous |
| Property management | Approved manager; changes need consent | On any change |
| Leasing | Follow leasing standards; some loans restrict certain lease types | Continuous |
| Financial tests | Minimum DSCR or debt yield on some loans | Often quarterly |
What do reporting covenants involve?
Lenders monitor the property through reports. A typical schedule asks for quarterly operating statements and rent rolls and annual financial statements within a set number of days after year end, and the loan may require a specific format or a certification by an officer of the borrower. Missing deadlines can lead to late fees and, if repeated, a default. Build the reporting calendar into the asset management plan from the first month; see the asset management checklist and the first 90 days after closing.
What happens when a financial test is missed?
Many loans, especially bridge and some CMBS loans, include a coverage or debt yield test. Missing it can trigger cash management: rent is collected into a lender-controlled account, and excess cash after expenses and debt service is held by the lender instead of being distributed. See cash sweeps and DSCR triggers. For investors, that means distributions can stop even though the loan is not in default.
Which breaches carry personal liability?
Most agency and CMBS loans are non-recourse with carve-outs: the guarantor becomes liable for losses, or the whole loan, if the borrower commits specific bad acts. Common carve-outs include fraud, misapplied rents or insurance proceeds, unapproved transfers, voluntary bankruptcy and breaches of the single-purpose entity covenants. See loan guarantors in a syndication.
This is one reason investor transfers and new capital need care: an investor interest moved without following the loan's transfer rules can become a covenant problem. See transfer restrictions and lender disclosure of investors.
What should investors ask?
- Does the loan have a coverage or debt yield test, and how close is the deal to it?
- What triggers cash management, and would it stop distributions?
- Who prepares and signs the lender reports?
- Which actions need lender consent, and has the sponsor asked before?
- What carve-outs apply, and who is the guarantor?
How DoorRaise fits in
DoorRaise does not lend or arrange loans. It helps sponsors raise equity for apartment buildings with 5 or more units from their friends and followers. DoorRaise forms the deal's LLC, prepares the offering documents, which describe the loan for investors, files Form D and verifies every investor's accreditation, in 506(b) and 506(c) deals. Investors fund by wire into escrow at Enterprise Bank & Trust, and distributions are quarterly by default. DoorRaise charges two flat fees: $1,500 to set up (non-refundable) and $5,000 a year for administration, the first year paid at closing from the money raised and only if the deal closes.
When your loan terms are in hand, start your deal.
FAQ
What are covenants on a commercial real estate loan?
They are the borrower's ongoing promises to the lender: things it must do, such as reporting and keeping insurance, and things it must not do without consent, such as transferring ownership or adding debt.
What happens if a borrower breaks a loan covenant?
It depends on the covenant and the loan: late fees, cash management, recourse under the guaranty for certain carve-outs, or a default.
Can a loan covenant stop distributions?
Yes. If a financial test triggers a cash sweep, excess cash may be held by the lender instead of distributed until the test is met again.
What is a single-purpose entity covenant?
A promise that the borrower owns only the financed property, keeps separate books and accounts, and does not take on unrelated business or debt.
Sources
- Fannie Mae Multifamily Selling and Servicing Guide
- Freddie Mac Multifamily Seller/Servicer Guide
- HUD, Multifamily Accelerated Processing Guide
This article is general information, not legal, tax or investment advice. Loan terms vary; the loan documents decide. DoorRaise is not a lender, law firm, broker-dealer, investment adviser or funding portal.