Real estate investors look for ways to earn a competitive return on investment while exposing themselves to minimal risk. One way to reduce investor or lender risk is through a hypothecation agreement. In this article, we’ll answer, “What is a hypothecation agreement?”
Then we show you an example hypothecation agreement form. We also discuss what you must know about hypothecation in real estate and elsewhere. Finally, we’ll discuss rehypothecation and answer a few frequently asked questions.
To answer “What is a hypothecation agreement?”, let’s first define hypothecation. It’s the pledging of collateral to secure a loan without relinquishing collateral ownership rights, possession, or title. A hypothecation agreement or hypothecation letter specifies the terms of the hypothecation arrangement.
Importantly, it states the legal recourse available to lenders in case of debtor default. Usually, recourse is through a lien on the collateral property. Indeed, if the debtor defaults on the loan, the lender can seize the collateral and sell it to make itself whole.
Here you can find a sample hypothecation agreement form from the SEC archives.
There are many aspects of hypothecation, which we’ll explore now.
Usually, hypothecation in real estate appears in a transaction like a mortgage on commercial or residential property. That is, a borrower pledges an asset as collateral to secure a real estate loan.
In doing so, the borrower does not give up ownership rights, title, or possession of the property. Nor does the borrower forgo any income that the property generates. On the contrary, the lender has no claim on the property’s cash flows.
Generally, a lender uses a hypothecation agreement when the owner of the collateral is not the obligor on the secured obligation. For instance, suppose Tom pledges his home as collateral for his fiancée Mary’s construction loan on her home.
Tom is the owner of the collateral (his home) but isn’t the obligor on the secured obligation (Mary’s home). Hence, the hypothecation agreement specifies that Tom’s home, but not Tom, secures Mary’s construction loan.
A hypothecation agreement may specify that a tenant cannot hypothecate its interest in a lease or premises without landlord consent. The example below shows this kind of hypothecation agreement.
The situation changes if the borrower defaults on the loan. That’s because the borrower provides a lien to the lender as part of the loan agreement. When a borrower defaults, the lender can exercise the lien by foreclosing on the property.
Then it can sell the property to recoup any losses. If any sale proceeds remain, they go to the former owner of the property.
A second mortgage complicates the picture. If a lender forecloses and takes possession of the property, it becomes responsible for paying the second mortgage until it sells the property.
Typically, the first and second lien holders work out an agreement on how to handle this unfortunate occurrence.
Although similar, a mortgage deed and a hypothecation agreement are not the same:
Investment hypothecation occurs when a trader or investor pledges collateral for a margin loan to purchase or short securities. Specifically, broker/dealers (BDs) offer margin accounts that allow traders to borrow up to 50% of the securities’ value. The margin account agreement contains a hypothecation agreement for the collateral.
Typically, the hypothecation agreement specifies important items:
The definition of rehypothecation is when a BD reuses a trader’s pledged collateral as collateral for the BD’s own trades and borrowings. This provides the creditor with leverage since the creditor doesn’t have to tie up its own assets. In the U.S., laws limit the amount of rehypothecation to no more than 140% of the original debit balance.
Interestingly, the creditor doesn’t carry the non-cash collateral available from rehypothecation on its balance sheet. A trader can indicate that it doesn’t want the BD to rehypothecate the trader’s collateral. The BD must then decide whether to grant a margin account to the trader.
In some cases, the trader receives compensation for allowing the BD to rehypothecate the trader’s collateral. That compensation can take the form of lower interest rate on margin loans or a rebate of fees.
When a Broker/Dealer grants a margin account to a trader, it must be able to handle three important risks. Normally, standard reports reveal these risky practices and prevent them from occurring.
Repurchase agreements, or repos, allow a party to sell securities to a second party and buy it back later. The first party pays less than the sale proceeds to buy back the security. The buyback discount is the seller’s source of profit on the repo agreement. Thus, repo agreements are actually loans in which the sold securities act as rehypothecated collateral.
Big banks and hedge funds use rehypothecated securities from their customers to undertake repo transactions. Most repos have an overnight term in which the buyback occurs the day after the sale. However, participants also use longer-term and open-ended repos.
A reverse repo is a repo transaction from the point of view of the borrower/buyer rather than the lender/seller.
The following language is for a real estate hypothecation agreement form and comes from Law Insider:
Hypothecation. Tenant shall not hypothecate, mortgage, or encumber Tenant’s interest in this Lease or in the Premises or otherwise use this Lease as a security device in any manner without the consent of Landlord, which consent Landlord may withhold in its sole and absolute discretion. Consent by Landlord to any such hypothecation or creation of a lien or mortgage shall not constitute consent to an assignment or other transfer of this Lease following foreclosure of any permitted lien or mortgage.
There are other types of hypothecation agreements, such as those for investments and repos. We leave it to the curious reader to ferret those out via appropriate Internet searches and their legal counsel.
Hypothecation in commercial real estate is the posting of collateral to secure a loan. Typically, a rental building operates as its own collateral. However, construction loans require other collateral since the borrower hasn’t built the underlying property yet.
They aren’t really the same. In a mortgage, the borrower hold’s the property’s title until the borrower repays the loan. In a hypothecation agreement, the borrower keeps title to the property.
In a pledge, you intend to transfer the asset to another owner. In hypothecation, your intent is to collateralize the asset to guarantee a loan. Importantly, you plan to maintain title to the hypothecated asset after you repay the loan.
Hypothecation letter is another name for a hypothecation agreement. Sometimes, we call a hypothecation agreement a hypothecation deed. These are all synonyms for the same document that specifies the terms of a hypothecation arrangement.
Broker/dealers routinely use hypothecation agreements when setting up margin accounts. In real estate, a landlord uses a hypothecation agreement to prevent subleasing. Also, lenders use hypothecation in real estate when a different property secures a mortgage or building loan.
Ronny was a pleasure to work with and is extremely knowledgeable. His hard work was never ending until the job was done. They handled a complex lease and guided us through entire process, including the paperwork. Not to mention a below market lease rate and more than all the features we needed in a site. We later used Assets America for a unique equipment financing deal where once again Ronny and team exceeded our expectations and our timeline. Thank you to Assets America for your highly professional service!
exp MFGroup Great experience with Assets AmericaGreat experience with Assets America. Fast turn around. Had a lender in place in 30 minutes looking to do the deal. Totally amazing. Highly recommend them to anyone looking for financing. Ronny is fantastic. Give them a call if the deal makes sense they can get it funded. Referring all our clients.
Assets America guided us every step of the wayAssets America guided us every step of the way in finding and leasing our large industrial building with attached offices. They handled all of the complex lease negotiations and contractual paperwork. Ultimately, we received exactly the space we needed along with a lower than market per square foot pricing, lease length and end of term options we requested. In addition to the real estate lease, Assets America utilized their decades-long financial expertise to negotiate fantastic rates and terms on our large and very unique multimillion dollar equipment purchase/lease. We were thankful for how promptly and consistently they kept us informed and up to date on each step of our journey. They were always available to answer each and every one of our questions. Overall, they provided my team with a fantastic and highly professional service!
The company is very capable, I would recommend Assets AmericaAssets America was responsible for arranging financing for two of my multi million dollar commercial projects. At the time of financing, it was extremely difficult to obtain bank financing for commercial real estate. Not only was Assets America successful, they were able to obtain an interest rate lower than going rates. The company is very capable, I would recommend Assets America to any company requiring commercial financing.
Assets America was incredibly helpful and professionalAssets America was incredibly helpful and professional in assisting us in purchasing our property. It was great to have such knowledgeable and super-experienced, licensed pros in our corner, pros upon which we could fully rely. They helped and successfully guided us to beat out 9 other competing offers! They were excellent at communicating with us at all times and they were extremely responsive. Having them on our team meant that we could always receive truthful, timely and accurate answers to our questions. We would most definitely utilize their services again and again for all of our real estate needs.
Assets America is a great company to work withAssets America is a great company to work with. No hassles. Recommend them to everyone. Professional, fast response time and definitely gets the job done.
Great experienceRonny at Assets America has been invaluable to us and definitely is tops in his field. Great experience. Would refer them to all our business associates.
We were very pleased with Assets America’s expertiseWe were very pleased with Assets America’s expertise and prompt response to our inquiry. They were very straight forward with us and helped a great deal. We referred them to all our business associates.
Worked with this company for decadesI’ve worked with this company for decades. They are reputable, knowledgeable, and ethical with proven results. I highly recommend them to anyone needing commercial financing.
Top-notch professionalRonny was incredibly adept and responsive – top-notch professional who arranged impressive term sheets.
Assets America helped us survive a very difficult timeAssets America helped us survive a very difficult time and we most definitely give them 5 stars!
Gave me direction to goRonny was very friendly and though we were unable to make something happen at the moment he gave me some direction to go.
Highly recommend them for any type of commercial financingMy business partner and I were looking to purchase a retail shopping center in southern California. We sought out the services of Ronny, CFO of Assets America. Ronny found us several commercial properties which met our desired needs. We chose the property we liked best, and Ronny went to work. He negotiated very aggressively on our behalf. We came to terms with the Seller, entered into a purchase agreement and opened escrow. Additionally, we needed 80 percent financing on our multimillion-dollar purchase. Assets America also handled the commercial loan for us. They were our One-Stop-Shop. They obtained fantastic, low, fixed rate insurance money for us. So, Assets America handled both the sale and the loan for us and successfully closed our escrow within the time frame stated in the purchase agreement. Ronny did and performed exactly as he said he would. Ronny and his company are true professionals. In this day and age, it’s especially rare and wonderful to work with a person who actually does what he says he will do. We recommend them to anyone needing any type of commercial real estate transaction and we further highly recommend them for any type of commercial financing. They were diligent and forthright on both accounts and brought our deal to a successful closing.