Mortgage can't be sold on secondary market - issue?

Question

My partners and I recently got a multi-family house under contract. During the due diligence phase we discovered  a local ordinance on the parcel which states a multi-family property could not be rebuilt if destroyed. This prevents the mortgage from being sold on the secondary market.

Our lender is willing to carry the primary note , but I am concerned about the long term viability of the property and the ability to sell, refinance, or how this affects the appreciation. I am a relatively new investor, but  I believe the government invests in nearly 90% of residential mortgages (unsure what percentage of that is on the secondary market) and I do not know how common it is for lenders to carry the primary note on a mortgage or a refinanced property.

Has anyone else ran into situations like this and am I making too big of deal out of this?

Andy Mirza · Answer

I don't know if it's most lenders or not. I'm not involved in originations of new loans so I couldn't tell you what their requirements are.

I believe that the market value of your duplex includes the availability of financing. Some lenders will lend on it, others will not, and so you'll have a market value that reflects this limitation because it will limit the buyers that will purchase your property. If lending loosens, your market value should go up. If lending tightens, it should go down.

Example: I bought about 2 dozen lower end condos at trustee sales in 2011-2013. These condos didn't qualify for any type of bank lending and the market consisted of cash buyers. The market prices reflected that and were very depressed. As the market has recovered, we've seen price gains but we expect even more as lenders begin to lend more and more on these types of condos.

Eric Lee · Answer

@Andy Mirza thank you for the prompt response. It is a duplex and therefore a residential loan. We got quotes from 6 lenders, but in this circumstance the lender is fine with carrying the note so we do not necessarily have to find a non-QM loan.

Based on your responses, I am gathering this local ordinance may limit some lenders during the sale and/or refinance, but shouldn't limit most lenders. Am I correct in that assumption?

Andy Mirza · Answer

@Eric Lee What kind of multi-family is this? 1-4 or 5+ units? If it's 1-4, your loan would be considered a residential loan, 5+ is commercial.

If it's a residential loan, it sounds like the originator wants to sell this as a Qualified Mortgage. Since QM's have far stricter underwriting, I understand why they would steer clear of this loan. Try another lender that can do non-QM loans.

How many lenders did you get quotes from? There's a lot of differences in what different lenders will and will not do.

Eric Lee · Answer

@Andy Mirza thank you for the response. The underwriter at the lender stated since this property would be defined as a non-compliant structure in the event of damage to the property in excess of 50%, they would not be able to sell the note on the secondary market.

The thought process I was going through was as follows:

- if the most lenders sell notes on the secondary market

- and if the note in question cannot be sold on the secondary market

- will this limitation affect the ability to sell/refi the house in the future assuming lenders will continue the preference to sell notes on the secondary market

Our analysis for the property showed we should sell the property before the term on the note is up. I want to make sure my partners and I are properly understanding the 'out strategy' to plan for realistic returns.

Andy Mirza · Answer

@Eric Lee I'm not sure I understand your conclusions correctly. The local ordinance should not affect the ability of the note holder to sell their note on the secondary market. It may affect the value of the note but I don't see why. If the property were destroyed, the lender would be covered by insurance and get a full payoff, assuming that the insurance was the right type and the lender had a safe LTV.

Lenders will take an ordinance like this into consideration during underwriting and will adjust their requirements accordingly. Requiring a lower LTV might be a response but it shouldn't be a deal killer.