The removal of the obligation is used in commercial real estate, to ensure that the Bank will issue a mortgage on the property after completion of construction or repair. This ensures that long-term commercial loans lender will pay off or “take out” the short-term construction loan and accrued interest.
Breaking down the ‘removal of the obligation
The removal of the obligations, reduce risks for lenders allow loans for the construction and development to continue. Developers typically borrow short-term funds to pay for construction projects. But projects can be delayed due to strikes, problems of the contractor, environmental issues and many other variables. Faced with higher costs from these failures, the Developer may be tempted to abandon the project and default on the loan. Therefore, lenders usually require take-out commitment from another lender that has agreed to be the permanent holder of the mortgage of the finished project.
How They Work
The removal of the obligation, also called a take-out loan or take-out agreement, gives the developer the opportunity to borrow a certain amount of money at an agreed rate (often tied to an index) for a certain period of time. The agreement will include a number of situations, such as the design and materials approval; the date of completion of the project; minimum occupancy before funds are released, perhaps 60 percent; and provisions for extending the start date of the loan, in case of delay. Commitment is often referred to as floor-to-ceiling, that is to be of a certain final amount of the loan for the project and a smaller amount of loan, if the contingency is not intended.
These conventional attempts to protect or shield both the permanent lender and the original short-term lender in case of problems on the road. The principle of operation is that it is the task of the developer and not the Bank, to ensure that the project is moving forward smoothly and, thus, banks will seek to limit their exposure to the problem of the developer.
The Funding Gap
Of course, the construction lender does not want to risk that the permanent lender will hold back funds due to unforeseen circumstances that may affect the repayment of the loan for construction. So the removal of the obligations also include Provisions on the financing gap, in case of any unforeseen circumstances cause a partial payment from the permanent lender. For example, if a new office tower they did not take enough units to meet the minimum point fill take-out commitment, the funding gap will ensure that the construction lender is paid back even if the final mortgage has not yet been issued.