01.27.2022 | Articles

Why Do We Care About Zoning Opinions vs. Zoning Endorsements?

By Angel K. Mozina, Brian F. Plunkett

When financing commercial real estate transactions, it is important that lenders determine whether a property satisfies or will satisfy all zoning and land use requirements affecting the mortgaged property. 

Zoning due diligence allows a lender to learn about all aspects and history of the property and understand any land use issues. At a minimum, lenders need to know if the property is or will be in compliance with applicable zoning ordinances with respect to usage, parking, setbacks, height, density, and area coverage requirements.  If the proposed financing entails development, construction or renovation of the property, lenders also need to know if the borrower has obtained (or can obtain) all required permits and approvals under applicable zoning ordinances.

Lenders should be aware that for diligence purposes, title exams, appraisal reports, and online searches of the property tax records, while potentially helpful, are not sufficient for purposes of confirming zoning law compliance.  Traditionally a lender will therefore require that a borrower provide a zoning opinion from borrower’s counsel which the lender can rely upon in making the mortgage loan.  In Massachusetts, a zoning report and/or opinion is issued by a zoning attorney who conducts a thorough review and analysis of the applicable zoning ordinances, bylaws and any other applicable laws.  The zoning opinion states that the property or its use (e.g., an office building or retail center) is either permitted under the applicable zoning ordinances or is “non-conforming” under an exemption or variance from the applicable zoning ordinances.  If the use or structure is non-conforming, that distinction is especially critical if a lender wants to finance a renovation or to determine whether a structure can be reconstructed after a casualty such as a fire.  By obtaining a zoning opinion, a lender obtains a level of assurance that the local zoning board will not disallow the use or require the property to be modified due to non-compliance.

Zoning opinions can be expensive however, and in competitive lending environments, borrowers will sometimes object to providing a zoning opinion for a property if there is no construction involved, if the existing buildings and improvements have not changed in years, or if there is no anticipated change in use for the property.  In these situations, a zoning endorsement (which is issued by the title insurance company as an “add-on” to the lender’s title insurance policy insuring the lender’s mortgage) may be a more affordable alternative for a borrower and may also be acceptable to the lender.  

A zoning endorsement insures a lender against loss or damage if the property does not meet the applicable zoning classification, if the actual intended use of the property is not authorized, or if a final court order prohibits the use of the building or requires removal or alteration to the building due to a violation of the zoning laws because of factors including the building’s height, floor space, parking, or other dimensional compliance issues.  Generally, a title company underwriter, like a zoning attorney, examines local zoning ordinances and zoning maps to ascertain allowable uses and classifications.  It may also request the lender obtain a zoning report stating the zoning classification and permitted uses.  For an existing structure, the title company will also require an inspection of the property and a review of surveys and existing plans.  The additional premium charged for a zoning endorsement is based on a percentage of the overall insured loan amount and typically ranges from $0.50 to $1.00 per $1,000 of coverage depending upon the size of the policy.  Consequently, zoning endorsements are frequently more cost effective and easier for a borrower to provide to a lender than a zoning opinion issued by borrower’s counsel.  While insurance claims are never easy battles to win, a zoning endorsement may even provide a lender with a better avenue for recovery for “zoning” losses since the claim is made against the title insurance company instead of bringing a claim against the zoning attorney under his/her malpractice policy. 

It is important to keep in mind that a zoning endorsement does not insure the lender against potential land use compliance issues, such as the improper filling of wetlands, overlay district requirements, surface water drainage or orders and conditions issued by a local conservation commission.  For this reason, a zoning opinion which addresses such land-use issues (in addition to zoning compliance) is still the recommended option for construction loans or for term loans secured by properties which were recently constructed.

We have found that different lenders have different requirements relating to a zoning opinion or a zoning endorsement.  A commercial mortgage-backed securities (CMBS) lender or major life insurance company will usually require both a zoning opinion and a zoning endorsement.  Commercial banks and credit unions will sometimes require either only a zoning opinion or in some instances only a zoning endorsement.  Sometimes, but not always, the size of the loan or the type of the loan will govern the choice between the two.  It is important to note that a lender’s counsel is not typically expected to provide any opinion as to zoning or land use compliance of a mortgaged property and like the lender, relies solely upon the information provided by other third-party professionals such as the borrower’s counsel, the surveyor, any site engineers, or zoning report companies retained to provide zoning information.   

Some borrowers will obtain a letter or certificate of compliance from the city or town in which the property is located and expect the lender to waive any further zoning/permitting diligence on that basis. We do not advise relying solely upon such a letter or certificate because the lender is generally not able to hold the city or town liable if the information or assertion of compliance turns out to be incorrect.  The municipality will not be prevented from claiming that the property has violated an applicable zoning statute or ordinance because it issued such a letter. It is also useful to note that the level of zoning due diligence varies depending on which state the property is located in.  It is not common practice in some states, unfortunately, for lenders to require zoning opinions. In addition, zoning endorsements are not available from title insurance companies in every state (they are unavailable in New York, for example).  

The following is a brief summary of the types of zoning endorsements that a title company may issue for undeveloped land, developed land, and land under development:

  • The ALTA 3.0 Endorsement is for unimproved land.  It recites the applicable zoning classification and use and insures against loss or damage by reason of inaccuracies in the information supplied or a final judicial determination invalidating the zoning ordinance establishing such classification and resulting in the prohibition of such uses.
  • The ALTA 3.1 Endorsement expands the ALTA 3.0 coverage and applies to improved land by insuring against a final court order prohibiting the present structure, and requiring removal or alteration of the present structure, because of violation of the zoning ordinance as to area, width or depth of the land as a building site, floor space area of the structure, setback of the structure, height of the structure or number of parking spaces.
  • The ALTA 3.2 Endorsement provides the coverage of an ALTA 3.1 Endorsement with respect to specified future improvements, which are detailed on a set of plans and specifications identified in the endorsement, provided that the improvements are constructed consistent with the plans and specifications.

It is important to determine early on in the loan closing process what level of zoning diligence for a mortgaged property a lender will require and what a borrower is willing to provide from a cost and timing point of view.  Some lenders may be willing to negotiate what will satisfy their zoning due diligence needs. Disputes late in the closing process are unfortunate and can delay loan closings and cause hard feelings between the borrower and the lender and their respective counsels.  We encourage borrowers and lenders to specify whether the lender will require a zoning opinion or zoning endorsement (or both) at the term sheet or commitment letter stage of the transaction.  Ultimately, a lender’s underwriting culture, risk threshold, and relationship with the borrower will determine its choice between a zoning opinion or a zoning endorsement.

This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.

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