Don’t Assume Your Real Estate Collateral Complies with Applicable Zoning Ordinances

Lenders should never assume that a property is in compliance with zoning restrictions because “it has been there for years” or “it has always operated that way.”

Zoning compliance is an important but often overlooked factor in the commercial loan closing process. Lenders should verify real property complies with applicable zoning ordinances prior to funding the loan.

Most commercial real estate is subject to municipal zoning ordinances imposing restrictions on setbacks, maximum densities, parking spaces, and limitations on heights, in addition to its approved uses. A municipality can shut down operations at a property that violates zoning use restrictions, impairing the borrower’s ability to repay its loan. Zoning ordinances may prohibit property from being restored or operating to its original use or condition after a major casualty takes place on the property.

The standard American Land Title Insurance Association (ALTA) title insurance policy expressly excludes any affirmative coverage for zoning matters, but the policy can endorsed to insure that the present use of the property complies with applicable zoning laws.

The ALTA 3-06 Zoning Endorsement provides insurance as to the zoning classification in which the land is located and the uses permitted in that zone. This endorsement is often issued in connection with a commercial loan that is secured by unimproved property. The ALTA 3.1-06 Zoning Endorsement applies to improved property and adds coverage regarding physical characteristics of the improvements, such as the area, height, width, and depth of the structure, the property setbacks, and the number of parking spaces. Another version, the ALTA 3.2-06 Zoning Endorsement, applies to land that is under development.

In order to underwrite the title insurance zoning endorsements, title insurers often require copies of the applicable zoning regulations, a current certificate of zoning compliance from the local building or zoning official, an adequate survey, or a zoning opinion of counsel. It is important to note that a zoning classification that is referenced in an appraisal will not suffice for a title insurer to issue the zoning endorsement.

Some municipalities issue zoning documents quickly, while others can take weeks or even months. Therefore, commercial lenders are well-advised to insist upon receiving evidence of zoning compliance and conformance from the title agent and/or the borrower at the beginning stages of the due diligence process.

Michael Smith is an attorney with Lerch, Early & Brewer focusing on the structuring, negotiation, documentation, due diligence, and closing of commercial lending transactions. For more information on ensuring your property is in compliance with zoning ordinances, contact Michael at (301) 657-0166 or [email protected].