The terms of your loan are dictated, in large part, by the strength of your collateral. Typically when you own real estate, the lender will secure it with a mortgage. However, if you lease the property, the lender will take a leasehold mortgage, which is different than a standard mortgage. Alternately, if you own the property but lease it to a third party, the lender may take an assignment of leases and rents.
Type of Collateral
A leasehold mortgage is given by a tenant to a lender to secure the tenant's interest in the leased property. This is common in scenarios with a ground lease. For example, a franchise owner leases land from a landlord and builds a fast food restaurant on the premises. The leasehold mortgage grants the lender a security interest in the building. To be able to do this, the lease with the land owner has to have a provision that the tenant can obtain such a mortgage. An assignment of leases is given by the landlord himself. The security for the lender in this case is the rent payments that the landlord receives from his tenants. Assignments of leases are often taken in conjunction with a mortgage on the property itself.
Documenting the Lien
For both a leasehold mortgage and assignment of leases, documentation is critical to protecting the lender. A leasehold mortgage is similar to a standard commercial mortgage document. However, the lender must also obtain a landlord's consent and a subordination, non-disturbance and attornment agreement, also known as an SNDA. This document assures the landlord that he is not risking his interest in the leased premises in connection with the transaction. Also, to ensure the lender can seize the tenant's personal property in default, it will file a UCC-1 on those assets as well. An assignment of leases is an independent document, but it is often recorded with a commercial mortgage. The mortgage gives the lender the right to seize the property. The assignment of leases allows the lender to keep any tenants in the building and collect rent until the lease expires.
Recording the Lien
Both leasehold mortgages and assignments of leases, as well as UCC-1s, are recorded with the appropriate authority, typically the County Clerk or Recorder of Deeds. The lender has to ensure that the title to the property is clear, meaning that there are no prior liens against the property. When the leasehold mortgage, UCC-1 or assignment of rents is sent for recording, it becomes first priority. Any subsequent mortgages or assignments are subordinate to the first lender's. That means that the first lender has to exercise his rights to seize the property or collect the rents before the subordinate lenders can do the same.
When a borrower fails to pay on the loan, the lender can declare it in default. It will then exercise its rights under the collateral documents. In the case of a leasehold mortgage, the lender will take possession of the leased premises, such as the fast food restaurant in the previous example. It will also seize any equipment and other personal properties as dictated by the UCC-1. The landlord will retain its interest in the land. In the case of an assignment of leases, the lender will seize the property, but in most cases, it will leave the tenant in place until the expiration of the lease term. The tenant will continue to pay rent, but it will go directly to the lender. At the end of the lease term, the lender can either renew the lease or inform the tenant that it will not do so. The latter scenario is more common since it is not the policy of many lenders to own real estate. The lender will sell the property as soon as it has the opportunity.