MEMORANDUM — PRIVILEGED & CONFIDENTIAL ATTORNEY WORK PRODUCT
FROM: Lisa Morrow and Marcus Leung, Calderwood & Harkness LLP
TO: Philip Hartmann, Calderwood & Harkness LLP
DATE: October 20, 2025
RE: Open Negotiation Issues — $240,000,000 Permanent CMBS Mortgage Loan; Fairwater Sun Belt I LLC through Fairwater Sun Belt XIV LLC (Co-Borrowers) and Clarendon Metropolitan Insurance Company (Lender)
MATTER NO.: 1036-00001
CLIENT: Fairwater Real Estate Investment Trust
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I. INTRODUCTION AND BACKGROUND
This memorandum catalogues and analyzes all material open negotiation issues arising from the initial loan document package circulated by Ashworth McPhail LLP (Joanna C. Wexler, lead partner) on behalf of Clarendon Metropolitan Insurance Company on approximately October 15, 2025. The purpose of this memorandum is to provide a comprehensive road map for the negotiation of the permanent loan documents, organized by document and by issue, with recommended borrower positions and supporting rationale for each open item. It is intended to serve as a working reference for the negotiation team and for ultimate review and decision-making by the client.
Documents Received. The initial loan document package circulated by Ashworth McPhail includes the following principal documents: (i) Loan Agreement; (ii) Promissory Note; (iii) Guaranty Agreement; (iv) Environmental Indemnity Agreement; (v) form Mortgage/Assignment of Leases and Rents/Security Agreement (Texas form, to be adapted for each applicable state); (vi) Cash Management Agreement; and (vii) form Amended and Restated Limited Liability Company Agreement for SPE Borrowers. We have conducted a detailed review of each of these documents, and the issues identified in this memorandum reflect the results of that review.
Transaction Summary. The proposed transaction is a $240,000,000 fixed-rate permanent CMBS mortgage loan to be made by Clarendon Metropolitan Insurance Company to Fairwater Sun Belt I LLC through Fairwater Sun Belt XIV LLC (collectively, the "Co-Borrowers"), each a Delaware limited liability company wholly owned, directly or indirectly, by Fairwater Operating Partnership, L.P. ("Fairwater OP"). The loan bears interest at a fixed rate of 6.25% per annum, has a ten (10)-year term, and amortizes on a thirty (30)-year schedule. Monthly principal and interest payments are approximately $1,477,846. Based on reported net operating income ("NOI") of $26,180,000 for the trailing twelve months, the proposed debt service coverage ratio ("DSCR") is approximately 1.476x ($26,180,000 NOI ÷ $17,734,152 annual debt service). The loan is non-recourse to the borrowers, subject to standard carve-out guaranty obligations from Fairwater Real Estate Investment Trust, a Maryland real estate investment trust ("Fairwater REIT" or the "Guarantor"), which is publicly traded on the New York Stock Exchange under the ticker symbol FWTR.
Collateral. The loan is secured by first-priority mortgage liens (or deeds of trust, as applicable by jurisdiction) on fourteen (14) multifamily residential properties (approximately 4,200 units in the aggregate), located across five Sun Belt states: Texas (5 properties), Georgia (3 properties), Florida (3 properties), North Carolina (2 properties), and Tennessee (1 property). The total appraised value of the fourteen-property portfolio is $385,000,000.
Co-Borrowers. The Co-Borrowers are Fairwater Sun Belt I LLC through Fairwater Sun Belt XIV LLC, each a Delaware limited liability company that is, or will be upon closing, wholly owned by Fairwater Operating Partnership, L.P. Each Co-Borrower holds title to one property within the collateral portfolio and is required to satisfy the special purpose entity ("SPE") requirements set forth in the loan documents.
Carve-Out Guarantor. Fairwater Real Estate Investment Trust, a Maryland real estate investment trust, is the proposed carve-out guarantor. Fairwater REIT is a publicly traded company listed on the NYSE under the symbol FWTR, with a market capitalization of approximately $1.85 billion and a total enterprise value of approximately $3.2 billion. Fairwater REIT, through Fairwater OP and its subsidiaries, owns and operates a portfolio of sixty-two (62) multifamily communities comprising approximately 18,400 units (pre-acquisition of the Sun Belt Portfolio).
Anticipated Securitization. The loan is anticipated to be securitized in the CLRN 2025-C14 CMBS trust, though the specific securitization vehicle is indicative and subject to final pooling by Clarendon Metropolitan. This securitization context is relevant to several of the negotiation issues discussed herein, as certain provisions in the loan documents may be driven by rating agency requirements, B-piece buyer preferences, or pooling and servicing agreement standards that limit the originating lender's flexibility to negotiate.
Financial Advisor. Fairwater's financial advisor, Beacon Ridge Capital Advisors LLC (Dennis P. Nakamura), has been consulted on certain economic points discussed in this memorandum, including reserve levels, defeasance mechanics, and the interplay between the permanent loan structure and Fairwater's broader capital markets strategy.
Organization of Memorandum. This memorandum is organized by loan document, with each section identifying the lender's position as reflected in the initial draft documents, our recommended borrower position, and the supporting rationale for each recommendation. Where applicable, we note the coordination with Crestline & Alderman LLP (Patricia S. Keene) on REIT-specific governance, tax, and compliance matters. We have also included a priority matrix in Section IX to assist the negotiation team in allocating leverage and identifying areas where compromise may be appropriate.
Target Closing Date. The target closing date for the permanent loan is November 28, 2025, with execution of all loan documents targeted for November 14, 2025. The existing bridge loan facility matures on December 31, 2025, which creates urgency to resolve all open issues promptly. As discussed in Section IX below, the current bridge DSCR of 1.169x is below the 1.20x extension threshold, which further underscores the importance of closing the permanent financing on schedule. We recommend resolving all substantive open issues no later than November 7, 2025, in order to permit sufficient time for final document preparation, execution, and closing.
II. LOAN AGREEMENT — OPEN ISSUES
The Loan Agreement is the principal operative document governing the rights and obligations of the Co-Borrowers and the Lender, and it contains the majority of the substantive negotiation points in this transaction. We have organized our comments on the Loan Agreement by subject matter, addressing each of the major areas of concern identified in our review of the Ashworth McPhail draft.
A. Non-Recourse Carve-Outs (Section 9.01 of Loan Agreement / Cross-Reference to Guaranty Agreement)
The non-recourse structure of the loan is fundamental to the transaction. Under the standard CMBS framework, the loan is non-recourse to the borrower entities except for certain enumerated "carve-outs" that fall into two categories: (i) "loss" carve-outs, under which the guarantor is liable for actual losses sustained by the lender as a result of specified actions or omissions by the borrower; and (ii) "full recourse" triggers, upon the occurrence of which the entire outstanding balance of the loan becomes fully recourse to the guarantor. The distinction between these two categories is critical, as the consequences of a full-recourse trigger are dramatically more severe than those of a loss carve-out.
1. Scope of Loss Carve-Outs (Lender's Position)
The Lender's draft includes an expansive list of "loss" carve-outs, making the Co-Borrowers and the Guarantor liable for actual losses arising from the following events or circumstances:
(a) Fraud or intentional misrepresentation by the borrower or any principal of the borrower in connection with the loan;
(b) Misapplication or misappropriation of rents, issues, and profits of the properties, insurance proceeds, or condemnation awards;
(c) Waste of the properties;
(d) Removal of personal property from the properties in violation of the loan documents;
(e) Breach of environmental representations, warranties, or covenants;
(f) Unpermitted transfers of the properties or interests in the borrower entities;
(g) Failure to maintain insurance as required under the loan documents; and
(h) Commingling of funds of the borrower entities with funds of any other person or entity.
While the general categories of loss carve-outs listed above are consistent with market practice, several of these carve-outs are drafted more broadly than market standard in ways that create meaningful exposure for the Guarantor. Two examples are particularly noteworthy:
Waste. The Lender's draft defines "waste" to include not only intentional physical waste of the properties but also the failure to make capital repairs and replacements, regardless of whether the borrower has available cash flow to fund such repairs. Under this formulation, a borrower that lacks sufficient operating income to fund a capital improvement project — even one that is discretionary in nature — could be deemed to have committed "waste," thereby triggering guarantor liability. This is an overbroad formulation that does not reflect the market-standard understanding of "waste" in the CMBS context and could expose Fairwater REIT to liability for circumstances that are beyond the borrower's reasonable control.
Misapplication of Rents. The Lender's draft defines "misapplication of rents" to include any application of rents by the borrower prior to the full funding of all reserves required under the loan documents. In practice, this means that any use of rental income by the borrower for operating expenses, distributions, or any other purpose before all reserve accounts are fully funded would constitute a "misapplication" triggering guarantor liability. This is inconsistent with the springing lockbox structure that we are requesting (discussed in Section II.B below) and would effectively impose a cash management regime from day one through the backdoor of the carve-out guaranty.
2. Full Recourse Triggers (Lender's Position)
The Lender's draft provides that the entire outstanding loan balance becomes fully recourse to the Co-Borrowers and the Guarantor upon the occurrence of any of the following events:
(a) A voluntary bankruptcy filing by any Co-Borrower;
(b) A collusive involuntary bankruptcy filing (i.e., an involuntary filing that is solicited, procured, or consented to by the borrower or any affiliate);
(c) A violation of SPE covenants contained in the organizational documents of any Co-Borrower or in the Loan Agreement;
(d) A violation of the transfer restrictions set forth in the Loan Agreement; and
(e) The incurrence of additional debt by any Co-Borrower in violation of the loan documents.
Items (a) and (b) — the voluntary and collusive involuntary bankruptcy triggers — are standard and universally accepted in CMBS non-recourse loans. However, items (c), (d), and (e) represent significant expansions of the full-recourse trigger framework beyond market convention. In particular, we note the following:
SPE Covenant Violations. The inclusion of SPE covenant violations as a full-recourse trigger, without any materiality qualifier, notice period, or cure right, is problematic. SPE covenants are numerous and technical in nature (e.g., maintenance of separate books and records, use of separate stationery, holding of separate meetings). A minor or inadvertent technical violation — for example, a failure to hold an annual organizational meeting of a borrower entity within the prescribed timeframe — should not, standing alone, cause the entire $240,000,000 loan to become fully recourse to the Guarantor. This result would be grossly disproportionate to the nature of the violation and inconsistent with the fundamental non-recourse bargain.
Transfer Restriction Violations. Similarly, a violation of the transfer restrictions as a full-recourse trigger raises significant concerns. Given the breadth of the transfer restrictions in the Lender's draft (discussed in Section II.D below), which purport to restrict even transfers of publicly traded shares of Fairwater REIT on the NYSE, the potential for an inadvertent "violation" is substantial. Any transfer restriction violation that triggers full recourse must be limited to intentional, material violations, and must be subject to notice and cure provisions.
Incurrence of Additional Debt. While incurrence of unauthorized debt by the SPE borrowers is a legitimate concern, characterizing this as a full-recourse trigger (rather than a loss carve-out) is not consistent with market practice for CMBS loans to institutional borrowers.
3. Recommended Borrower Position
We recommend the following positions on the non-recourse carve-out provisions:
(a) Waste: Narrow the "waste" carve-out to intentional physical waste of the properties. The definition should expressly exclude the failure to make discretionary capital improvements or repairs to the extent that the borrower does not have available cash flow (after payment of debt service and required operating expenses) to fund such improvements.
(b) Misapplication of Rents: Narrow the "misapplication of rents" carve-out to rents collected after a Cash Management Period has been triggered and the springing lockbox is in effect. Prior to the commencement of a Cash Management Period, the borrower should have full discretion to apply rents in the ordinary course of business without risk of triggering guarantor liability.
(c) Full Recourse Triggers: Limit full-recourse triggers to (i) voluntary bankruptcy filing by any Co-Borrower and (ii) collusive involuntary bankruptcy. SPE covenant violations, transfer restriction violations, and incurrence of unauthorized debt should be reclassified as "loss" carve-outs (not full-recourse triggers), subject in each case to a materiality qualifier and a thirty (30)-day notice and cure period.
(d) Fraud Qualifier: Add a knowledge and intent qualifier for the fraud carve-out, limiting the carve-out to "actual fraud" (as opposed to constructive fraud or negligent misrepresentation). The guarantor should not be liable for misstatements or omissions that are not made with actual knowledge of their falsity and with intent to deceive.
Rationale. Market-standard CMBS non-recourse carve-outs draw a clear distinction between "loss" items (under which the lender recovers actual damages from the guarantor) and "full recourse" triggers (under which the entire loan becomes recourse). The purpose of the full-recourse trigger is to deter the borrower from engaging in conduct — specifically, a voluntary bankruptcy filing or collusive involuntary filing — that would undermine the lender's ability to exercise its remedies against the collateral. Extending full recourse to technical SPE violations or transfer restriction breaches without any materiality qualifier, notice period, or cure right is inconsistent with this deterrence rationale and creates disproportionate risk for Fairwater REIT, a publicly traded entity with a total enterprise value of $3.2 billion that serves as guarantor for numerous loan facilities. Overly broad full-recourse triggers could also have adverse implications for Fairwater REIT's financial reporting and disclosure obligations under SEC regulations, as the potential for full recourse exposure on this magnitude would require prominent disclosure and could affect the company's credit profile and stock price.
B. Cash Management / Lockbox Provisions (Loan Agreement Article VII)
The cash management structure is a critical component of the loan and has significant implications for Fairwater's day-to-day operations, treasury management, and ability to meet its REIT distribution requirements.
1. Hard vs. Springing Lockbox
Lender's Position. The Lender's draft imposes a hard lockbox from day one of the loan. Under this structure, all rents and other income from the fourteen properties would be deposited directly into a lender-controlled lockbox account, and the Lender would control the disbursement waterfall at all times throughout the loan term — not only during periods of financial distress or default but also during periods of strong performance. This is a restrictive structure that is more commonly associated with single-asset CMBS loans or loans secured by properties with higher credit risk profiles.
Borrower's Position. We strongly recommend that the lockbox be structured as a springing lockbox, triggered only upon the occurrence of a "Cash Management Period" (as defined below). Outside of a Cash Management Period, the Co-Borrowers should retain full control over the collection and application of rents through their own operating accounts. A springing lockbox is the appropriate structure for a loan of this nature, secured by a stabilized, institutional-quality multifamily portfolio with a DSCR of 1.476x, sponsored by a publicly traded REIT with a strong credit profile.
The difference between a hard lockbox and a springing lockbox is substantial from an operational perspective. Under a hard lockbox, every dollar of rental income from the 4,200 units across fourteen properties must flow through a lender-controlled account, and every disbursement — including routine operating expenses, property management fees, and distributions — must be processed through the lender's waterfall. This imposes a significant administrative burden on the borrower and its property management team, introduces delays in the payment of ordinary-course expenses, and limits the borrower's flexibility to manage its cash flow in the most efficient manner. For a large, institutional borrower like Fairwater, with established treasury functions and a demonstrated track record of timely payment, these restrictions are unnecessary and commercially burdensome.
2. Definition of Cash Management Period / DSCR Trigger
Lender's Position. The Lender's draft defines a "Cash Management Period" as commencing upon (i) the DSCR for the portfolio falling below 1.25x (tested on a quarterly basis), or (ii) the occurrence and continuance of an Event of Default under the Loan Agreement. The DSCR trigger of 1.25x is, in our view, set too high relative to the stabilized DSCR of 1.476x. The spread between the trigger level (1.25x) and the stabilized DSCR (1.476x) is only approximately 15.3%, which leaves insufficient cushion for normal market fluctuations, seasonal variations in occupancy, or temporary disruptions in rental income.
Borrower's Position. We recommend that the DSCR trigger for the commencement of a Cash Management Period be set at 1.10x, or at most 1.15x. A trigger at 1.10x is consistent with the DSCR covenant in the existing bridge loan facility and reflects a level of financial distress that genuinely warrants enhanced lender oversight of cash management. A trigger at 1.25x, by contrast, could be activated by relatively modest declines in NOI — for example, a 15% decline in NOI from $26,180,000 to approximately $22,253,000 would bring the DSCR to approximately 1.25x. In Sun Belt multifamily markets, where seasonal occupancy fluctuations, insurance cost increases, and property tax reassessments can materially affect NOI on a quarter-to-quarter basis, a 1.25x trigger creates a meaningful risk of triggering a Cash Management Period during what would otherwise be considered normal market conditions.
We further recommend that the Cash Management Period include a "Hysteresis" or cure provision: the Cash Management Period should terminate when the DSCR is restored to at least 1.20x for two (2) consecutive calendar quarters. This cure-at-a-higher-level approach avoids the problem of rapid cycling in and out of a Cash Management Period, which creates administrative burdens for both parties and uncertainty for the borrower's operations. The 1.20x cure threshold (versus a 1.10x trigger) provides an appropriate margin of comfort for the lender while ensuring that the lockbox mechanism is not activated and deactivated repeatedly due to minor DSCR fluctuations.
3. Disbursement Waterfall
Lender's Position. The Lender's draft specifies the following disbursement waterfall for funds in the lockbox account during a Cash Management Period:
(i) Payment of monthly debt service (principal and interest);
(ii) Deposit to the monthly tax and insurance escrow accounts;
(iii) Deposit to the capital expenditure reserve;
(iv) Deposit to the leasing commission/tenant improvement reserve;
(v) Payment of budgeted operating expenses (subject to lender approval);
(vi) Deposit to any other required reserve accounts; and
(vii) Excess cash flow to the borrower.
Borrower's Position. The waterfall as drafted does not include any priority item for distributions to Fairwater Operating Partnership, L.P. (and upstream to Fairwater REIT) necessary for Fairwater REIT to satisfy the ninety percent (90%) distribution requirement for qualification as a real estate investment trust under Sections 856–860 of the Internal Revenue Code of 1986, as amended (the "Code"). This is a critical omission.
We recommend that the waterfall be modified to include, as a priority item above the excess cash flow line (and preferably above or at the same level as the other reserve deposits), a distribution in an amount equal to the Co-Borrowers' allocable share of Fairwater REIT's minimum required REIT distribution. At a minimum, this distribution should be included immediately following debt service and tax/insurance escrow deposits.
Rationale. Section 857(a)(1) of the Code requires a REIT to distribute at least ninety percent (90%) of its taxable income (determined without regard to the deduction for dividends paid and excluding net capital gain) to its shareholders annually in order to qualify for the favorable pass-through tax treatment afforded to REITs. Failure to satisfy this distribution requirement would result in entity-level taxation of Fairwater REIT's income at regular corporate rates and, if the failure were to continue for more than one taxable year, could result in the loss of REIT status altogether. The consequences of losing REIT status would be severe — entity-level taxation, potential breach of covenants in other debt facilities, adverse impact on stock price, and loss of investor confidence. These consequences would also be adverse to the Lender, as the Guarantor's creditworthiness would be significantly impaired. CMBS lenders customarily accommodate this requirement for publicly traded REIT borrowers, and the inclusion of a REIT distribution carve-out in the waterfall is consistent with market practice.
4. Recommended Position — Summary
Our recommended position on the cash management provisions, in summary, is as follows:
(a) Springing lockbox triggered upon DSCR falling below 1.10x (or at most 1.15x); Cash Management Period cures when DSCR is restored to 1.20x for two (2) consecutive calendar quarters;
(b) REIT distribution carve-out in the disbursement waterfall, permitting distributions to Fairwater OP (and upstream to Fairwater REIT) in amounts necessary to satisfy the 90% distribution requirement for REIT qualification;
(c) Borrower retains full control of operating accounts and cash management outside of a Cash Management Period; and
(d) During a Cash Management Period, operating expenses are paid in accordance with an approved budget without item-by-item lender approval, subject to a variance tolerance of five to ten percent (5–10%) per line item.
C. Casualty and Condemnation Provisions
1. Threshold for Lender's Right to Apply Proceeds
Lender's Position. The Lender's draft provides that the Lender may elect to apply casualty or condemnation proceeds to reduce the outstanding principal balance of the loan (rather than releasing such proceeds to the borrower for restoration of the damaged or taken property) if (i) any individual casualty or condemnation event results in loss or damage exceeding $500,000, or (ii) the aggregate unrestored losses across the portfolio exceed $1,000,000. Below these thresholds, the borrower may use the proceeds for restoration, subject to standard lender conditions and oversight.
Analysis. These thresholds are unreasonably low in the context of this transaction. The collateral consists of fourteen multifamily properties with a total appraised value of $385,000,000, located across Sun Belt states that are subject to elevated weather risk, including hurricanes, tropical storms, hail, and severe thunderstorms. Properties in Texas, Florida, and coastal Georgia and North Carolina face particularly acute exposure to weather-related casualty events. A single wind or hail event at one property could easily result in damage exceeding $500,000 — this is not an extraordinary event but rather a foreseeable and routine occurrence in these markets. At a $500,000 per-event threshold, the Lender would have the right to capture the insurance proceeds and apply them to principal reduction, depriving the borrower of the ability to restore the property to its pre-casualty condition and maintain the property's income-producing capacity.
Similarly, the $1,000,000 aggregate threshold is inadequate. Over a ten-year loan term, across fourteen properties in hurricane- and storm-prone regions, cumulative unrestored losses of $1,000,000 are virtually certain to be exceeded. The aggregate threshold, as drafted, would effectively give the Lender the perpetual right to apply proceeds to principal after relatively minor cumulative events.
2. Recommended Borrower Position
We recommend the following modifications to the casualty and condemnation provisions:
(a) Per-Event Threshold: Increase the per-event threshold from $500,000 to $2,500,000. This represents approximately 0.65% of the total appraised portfolio value of $385,000,000 and is a reasonable threshold that distinguishes between routine damage events (which should be restored by the borrower) and significant casualties (which may warrant lender involvement and potential principal reduction).
(b) Aggregate Threshold: Increase the aggregate threshold from $1,000,000 to $5,000,000.
(c) Below-Threshold Events: For casualty or condemnation events below the applicable threshold, insurance or condemnation proceeds should be released directly to the borrower for restoration without lender approval, subject only to the borrower providing evidence of completion of restoration within one hundred eighty (180) days (or such longer period as may be reasonably required for the scope of work).
(d) Above-Threshold Events: For events exceeding the threshold, the Lender may elect to apply proceeds to the outstanding principal balance or may permit restoration, subject to standard conditions including (i) Lender approval of plans and specifications for restoration, (ii) a completion deadline of twelve (12) months (or longer if reasonably required), (iii) a DSCR test confirming that the post-casualty DSCR (after restoration) will meet or exceed the trigger DSCR for a Cash Management Period, and (iv) evidence that total insurance proceeds and borrower equity contributions are sufficient to complete the restoration.
(e) Condemnation — Partial Takings: Partial takings below the per-event threshold should not trigger the Lender's right to apply condemnation awards to principal. Only complete takings, or material partial takings that render the affected property economically unviable (e.g., loss of more than twenty-five percent (25%) of the units or land area of a property), should give the Lender the right to elect prepayment application.
Rationale. The Sun Belt Portfolio comprises fourteen properties with a total appraised value of $385,000,000. Properties in Texas (five properties), Florida (three properties), and coastal areas of Georgia and North Carolina face elevated exposure to weather-related risk. Low thresholds for lender intervention in casualty events would permit the Lender to capture insurance proceeds for principal reduction, depriving the borrower of the ability to restore the property and maintain its NOI. From a portfolio management perspective, the borrower has a strong economic incentive to restore damaged properties promptly, as unremedied damage reduces both NOI and property value. The borrower's interests and the lender's interests are aligned in this regard, and the thresholds should reflect the scale and geographic diversity of the portfolio.
D. Transfer Restrictions and Permitted Transfers
1. Lender's Position
The Lender's draft contains a broad prohibition on all direct and indirect transfers of interests in the Co-Borrower entities, the properties, or the Guarantor without the prior written consent of the Lender. As currently drafted, the transfer restrictions contain no exceptions for:
(a) Transfers of publicly traded shares of Fairwater REIT on the New York Stock Exchange;
(b) Intra-REIT organizational restructurings (i.e., transfers of interests in the Co-Borrowers to other wholly owned subsidiaries or affiliates within the Fairwater organizational structure); or
(c) Changes in the management, board of trustees, or executive officers of Fairwater REIT.
The breadth of these restrictions is commercially unreasonable for a publicly traded REIT borrower and inconsistent with CMBS market convention.
2. Recommended Borrower Position
We recommend the following carve-outs and modifications to the transfer restriction provisions:
(a) Publicly Traded Shares. An express carve-out for transfers of publicly traded shares of Fairwater Real Estate Investment Trust (NYSE: FWTR) on a national securities exchange or in the over-the-counter market. This carve-out is essential for any publicly traded entity and is universally included in CMBS loans to public REIT borrowers. Without this carve-out, every purchase and sale of Fairwater REIT shares on the NYSE — transactions over which the borrower has no control — would technically constitute a prohibited "indirect transfer" requiring lender consent.
(b) Intra-REIT Transfers. A carve-out for intra-REIT transfers, defined as transfers of direct or indirect interests in the Co-Borrowers to wholly owned subsidiaries or affiliates within the Fairwater organizational structure, provided that (i) the Guarantor remains Fairwater Real Estate Investment Trust (or a successor entity with equal or greater creditworthiness), (ii) all SPE covenants continue to be satisfied, and (iii) the transferee entity assumes all obligations of the transferor under the loan documents. We note that Ashworth McPhail has indicated in the October 22, 2025 negotiation update that Clarendon Metropolitan has agreed in principle to permit intra-REIT transfers; we should memorialize this agreement in the definitive loan documents with appropriate specificity.
(c) Board and Management Changes. A carve-out for changes in the board of trustees, executive officers, and senior management of Fairwater REIT, provided that the existing property management agreement with Fairwater Residential Management LLC remains in full force and effect, or an acceptable replacement property manager meeting specified experience and performance criteria is engaged. Changes in the board and management of a publicly traded REIT are routine events that occur in the ordinary course of the company's governance and should not require lender consent or trigger a transfer restriction violation.
(d) REIT Qualification Safeguard. A provision prohibiting any transfer that would cause Fairwater REIT to fail to qualify as a REIT under the Code. This provision protects both the borrower and the lender by ensuring that the Guarantor's REIT status — and the tax and economic benefits flowing from that status — is preserved.
(e) Assumption Provision. A one-time assumption right permitting a successor entity to assume the loan obligations, subject to the following conditions: (i) the successor entity meets specified minimum credit, net worth, and multifamily management experience thresholds; (ii) the Lender approves the assumption (such approval not to be unreasonably withheld, conditioned, or delayed); (iii) payment of an assumption fee equal to one percent (1%) of the then-outstanding principal balance; and (iv) delivery of replacement guaranty, legal opinions, and such other documents as the Lender may reasonably require.
3. Rationale. Fairwater is a publicly traded REIT on the NYSE. Restricting transfers of publicly traded equity interests is impractical, commercially unreasonable, and universally excluded from CMBS transfer restrictions for public REIT borrowers. The REIT organizational structure requires flexibility for intra-group transfers for tax planning, operational restructuring, and compliance purposes. The inability to make such transfers without lender consent could impair Fairwater's ability to manage its portfolio and organizational structure efficiently and could create conflicts with Fairwater's obligations to its public shareholders.
E. Reserve Requirements
1. Tax and Insurance Reserves
Lender's Position. The Lender's draft requires monthly escrow deposits of one-twelfth (1/12) of estimated annual property taxes and insurance premiums from the closing date, regardless of whether a Cash Management Period is in effect.
Borrower's Position. We recommend that the tax and insurance escrow requirement be structured as a springing reserve, consistent with the springing lockbox structure discussed in Section II.B above. Outside of a Cash Management Period, the Co-Borrowers should be permitted to self-manage their tax and insurance payment obligations without escrow, provided that the Co-Borrowers furnish evidence of timely payment upon request.
Rationale. Fairwater is a large, institutional borrower with established treasury functions, a dedicated tax and insurance management team, and a demonstrated track record of timely tax and insurance payments across its sixty-two (62)-community portfolio. Requiring day-one escrow of tax and insurance obligations imposes an unnecessary liquidity burden and administrative cost on the borrower. Estimated annual property taxes across the fourteen-property portfolio are approximately $4,500,000, and annual insurance premiums are approximately $3,800,000 (total approximately $8,300,000, or approximately $691,667 per month). Requiring the borrower to deposit these amounts into an escrow account from which the borrower earns little or no interest represents a material opportunity cost.
2. Capital Expenditure Reserve
Lender's Position. The Lender's draft requires a capital expenditure reserve funded at $300 per unit per year (4,200 units × $300 = $1,260,000 annually, or $105,000 per month).
Borrower's Position. We recommend a capital expenditure reserve of $250 per unit per year ($1,050,000 annually, or $87,500 per month). The properties in the Sun Belt Portfolio are of relatively recent construction, with original build dates ranging from 2014 to 2021. As a result, the near-term capital expenditure needs of the portfolio are limited, and a per-unit reserve of $300 overstates the likely capital requirements during the first several years of the loan term.
As an alternative, we recommend a stepped structure: an initial capital expenditure reserve of $200 per unit per year for the first three (3) years of the loan term (through approximately November 2028), stepping up to $300 per unit per year for the balance of the loan term. This structure reflects the newer vintage of the portfolio and the expectation that capital expenditure needs will increase as the properties age.
3. Leasing Commission / Tenant Improvement Reserve
Lender's Position. The Lender's draft requires a leasing commission and tenant improvement reserve funded at $50 per unit per year ($210,000 annually).
Borrower's Position. We recommend the elimination of the leasing commission reserve entirely. Multifamily properties incur minimal leasing commissions compared to commercial office or retail assets. Apartment leasing is typically handled by on-site leasing staff who are compensated through base salary and performance bonuses included in the property's operating budget. The Sun Belt Portfolio has a weighted average occupancy of 93.7%, demonstrating strong demand in the relevant markets. There is no need for a dedicated reserve to fund third-party leasing commissions that are unlikely to be incurred.
If the Lender insists on a leasing commission reserve, we recommend a maximum of $25 per unit per year ($105,000 annually), which is more reflective of the actual leasing costs for multifamily properties. This reserve requirement is more customary for CMBS loans secured by office or retail properties, where tenant improvement allowances and brokerage commissions can be substantial.
4. Replacement Reserve Mechanics
With respect to all reserve accounts, we recommend the following procedural provisions:
(a) All reserve funds should be held in interest-bearing accounts at the cash management bank, with the borrower entitled to all interest earnings on the reserve accounts;
(b) Disbursement from reserve accounts for expenditures below $100,000 per request should be made upon the borrower's certification (accompanied by invoices or other customary evidence) without the requirement for a lender inspection or lender approval; and
(c) Disbursement from reserve accounts for expenditures of $100,000 or more per request should be subject to customary lender approval, which should not be unreasonably withheld or delayed.
F. Prepayment and Defeasance Mechanics
1. Lockout Period
Lender's Position. The Lender's draft imposes a two (2)-year hard lockout period from the closing date, during which no prepayment of the loan is permitted. The lockout period would expire on approximately November 28, 2027.
Borrower's Position. A two-year hard lockout is generally consistent with market practice for ten-year CMBS loans. We have no objection to this provision.
2. Defeasance After Lockout
Lender's Position. The Lender's draft permits defeasance of the loan from the expiration of the lockout period through the date that is ninety (90) days prior to the maturity date. The defeasance must be accomplished using U.S. Treasury obligations in amounts sufficient to generate payments equal to the scheduled principal and interest payments on the loan through the maturity date, plus any balloon payment due at maturity. The Lender's draft further requires that:
(a) The defeased collateral (i.e., the portfolio of U.S. Treasury obligations) be confirmed by an independent certified public accountant as sufficient to make all scheduled loan payments;
(b) The defeased collateral be rated by at least one nationally recognized statistical rating organization (the specific agency to be identified by the Lender), with the borrower bearing the cost of such rating confirmation;
(c) A successor borrower — a newly formed Delaware LLC satisfying all SPE requirements — assume the defeased loan and hold the defeasance collateral; and
(d) The borrower pay all costs associated with the defeasance, including accountant's verification fees, rating agency fees, and legal fees for the formation and documentation of the successor borrower.
Borrower's Position. The defeasance provisions are generally consistent with market practice, and we have limited objections. However, we recommend the following modifications, as discussed in further detail below.
3. Open Period
The Lender's draft provides that during the last ninety (90) days of the ten-year loan term (approximately August through November 2035), prepayment is permitted without any prepayment premium or defeasance requirement. This is a standard "open period" provision, and we have no objection.
4. Recommended Borrower Positions on Defeasance
We recommend the following modifications and additions to the defeasance provisions:
(a) Partial Defeasance. The borrower should have the right to partial defeasance — that is, the right to defease a portion of the loan allocated to one or more individual properties and obtain a release of the mortgage lien on those properties. This is an important portfolio management tool for Fairwater, as it would permit the disposition of individual properties during the loan term without requiring a full defeasance of the entire $240,000,000 loan.
(b) Partial Defeasance Amount. Upon partial defeasance, the borrower would defease the "Allocated Loan Amount" (as defined below) for the property being released, plus a premium of fifteen percent (15%) of the Allocated Loan Amount. Thus, the defeasance amount for any released property would equal 115% of the Allocated Loan Amount. The Allocated Loan Amounts for each of the fourteen properties are set forth in Appendix B to this memorandum.
(c) No Post-Release DSCR or LTV Test. If the defeasance amount is calculated at 115% of the Allocated Loan Amount, no post-release DSCR or loan-to-value test should be required. The 15% premium provides the Lender with a sufficient cushion to ensure that the remaining loan is adequately supported by the remaining collateral. Requiring a separate post-release DSCR or LTV test in addition to the 115% defeasance amount would impose a double requirement that could frustrate the borrower's ability to release individual properties.
(d) Defeasance Costs. While the borrower accepts responsibility for defeasance costs (accountant verification, rating agency fees, legal fees for the successor borrower), we recommend that the borrower have the right to select its own defeasance consultant from a list of nationally recognized defeasance service providers, or that defeasance costs be subject to a reasonable cap.
Rationale. Partial defeasance and release flexibility is important for REIT portfolio management. Fairwater's investment strategy involves active asset management, including the periodic disposition of properties that no longer fit the portfolio's investment criteria. Without partial defeasance provisions, the cross-collateralized structure of the loan would effectively prevent Fairwater from disposing of any individual property during the loan term — even a property that is underperforming or that could be sold at a premium — absent a full defeasance of the entire $240,000,000 loan. This would be an unacceptable constraint on Fairwater's portfolio management flexibility.
G. Reporting Requirements and Lender Approval Rights
1. Financial Reporting
Lender's Position. The Lender's draft imposes the following financial reporting requirements:
(a) Monthly property-level operating statements, delivered within thirty (30) days after the end of each calendar month;
(b) Quarterly consolidated financial statements of the Co-Borrowers and the Guarantor, delivered within forty-five (45) days after the end of each fiscal quarter;
(c) Annual audited financial statements of the Guarantor (Fairwater REIT), delivered within ninety (90) days after the end of each fiscal year;
(d) Annual audited property-level financial statements for each of the fourteen properties, delivered within ninety (90) days after the end of each fiscal year; and
(e) Annual operating budget for each property, submitted to the Lender for approval at least thirty (30) days prior to the commencement of each fiscal year.
Borrower's Proposed Modifications. We recommend the following modifications to the financial reporting requirements:
(a) Monthly Operating Statements. We accept the requirement for monthly property-level operating statements, provided that such statements may be unaudited. However, we request that the delivery period be extended from thirty (30) days to forty-five (45) days after month-end. A thirty-day delivery period is operationally challenging for a fourteen-property portfolio requiring consolidation of data from five states and multiple property management teams.
(b) Quarterly Statements. The forty-five (45)-day delivery period for quarterly statements is acceptable and is consistent with Fairwater REIT's SEC reporting obligations. As a large accelerated filer, Fairwater REIT is required to file its Form 10-Q with the SEC within forty (40) days after the end of each fiscal quarter. The quarterly statements delivered to the Lender should be permitted to be in the same form as the financial statements included in Fairwater's quarterly 10-Q filings.
(c) Annual Audited Guarantor Statements. The ninety (90)-day delivery period for annual audited financial statements of the Guarantor is standard and acceptable. Fairwater REIT's annual financial statements are audited by Whitmore Hargrove & Co., P.C. (Christine M. Rowley, engagement partner). The borrower should be expressly permitted to satisfy this requirement by delivering a copy of Fairwater REIT's Annual Report on Form 10-K as filed with the SEC, which includes the audited financial statements.
(d) Annual Property-Level Statements. We request that property-level financial statements be unaudited. It is not standard CMBS practice to require individual property-level audited financial statements for a cross-collateralized portfolio loan. The standard approach is to provide unaudited property-level statements, with the guarantor-level audit conducted at the portfolio level. The cost of conducting fourteen separate property-level audits annually would be substantial and unnecessary.
(e) Annual Budget. The annual budget submission is acceptable as an informational item. However, we object to the characterization of the annual budget as requiring "lender approval" in a manner that could be construed as binding the borrower to the budgeted line items. The annual budget should be submitted for the Lender's information and review, with Lender approval "deemed granted" if the Lender does not respond with specific objections within thirty (30) days after receipt. The approved budget should serve as a guideline for operating expense payments during a Cash Management Period (as discussed in Section V.B below) but should not be a binding constraint on the borrower's operations outside of a Cash Management Period.
2. Lender Approval Rights — Property Management
Lender's Position. The Lender's draft requires prior written Lender approval for any replacement of the property management company managing the properties.
Borrower's Position. The current property manager for the Sun Belt Portfolio is Fairwater Residential Management LLC, a wholly owned affiliate of Fairwater REIT, which assumed management of the properties effective July 1, 2025. We recommend the following framework:
(a) The borrower should have the right to self-manage the properties through Fairwater Residential Management LLC or any other affiliate of Fairwater REIT without Lender consent, provided that the affiliated property manager has at least five (5) years of experience managing multifamily properties of similar size and quality in comparable markets.
(b) Replacement of the property manager with a third-party (non-affiliated) management company should require Lender approval, which shall not be unreasonably withheld, conditioned, or delayed, and the Lender shall respond to any approval request within thirty (30) days.
(c) In all cases, the property management fee shall not exceed four percent (4%) of gross revenues (or such higher percentage as may be approved by the Lender).
3. Lender Approval Rights — Material Leases and Modifications
Lender's Position. The Lender's draft appears to require Lender approval for "material leases" without clearly distinguishing between standard residential apartment leases and any commercial or retail leases at the properties.
Borrower's Position. For multifamily properties, individual residential apartment leases should not require Lender approval. The properties in the Sun Belt Portfolio are multifamily residential communities in which leases are entered into and renewed on a daily basis in the ordinary course of operations. Requiring Lender approval for each of the approximately 4,200 individual apartment leases (with typical lease terms of twelve months) would be impractical and unworkable. Lender approval should be required only for commercial or retail leases (if any exist at the properties) that exceed a specified threshold — we recommend leases in excess of 5,000 square feet or with annual base rent in excess of $100,000. The borrower should also have the right to modify the standard residential lease form without Lender approval, provided that any modification does not materially impair the Lender's security interest in the rents and leases.
III. GUARANTY AGREEMENT — OPEN ISSUES
A. Scope of Non-Recourse Carve-Out Guaranty
This section should be read in conjunction with Section II.A of this memorandum, which addresses the scope of the non-recourse carve-outs in the Loan Agreement. The Guaranty Agreement is the instrument through which Fairwater Real Estate Investment Trust (Maryland REIT, EIN 52-2847193) assumes liability for the enumerated carve-out obligations.
Lender's Position. The Lender's draft Guaranty Agreement makes the Guarantor liable for the full outstanding balance of the loan upon the occurrence of any full-recourse trigger event. As discussed in Section II.A.2, the full-recourse trigger events include not only voluntary bankruptcy and collusive involuntary bankruptcy (which are market standard) but also SPE covenant violations, transfer restriction violations, and incurrence of unauthorized debt (which are not market standard as full-recourse triggers).
Recommended Position. We reiterate the positions set forth in Section II.A.3: full-recourse triggers should be narrowed to (i) voluntary bankruptcy filing and (ii) collusive involuntary bankruptcy. SPE covenant violations, transfer restriction violations, and unauthorized debt incurrence should be reclassified as "loss" carve-outs, subject to materiality qualifiers and notice/cure provisions.
In addition, we recommend the following specific modifications to the Guaranty Agreement:
(a) Environmental Carve-Out. The Guaranty Agreement should reference and be coextensive with the separate Environmental Indemnity Agreement (discussed in Section IV below). The environmental indemnification obligations should not be duplicated in the Guaranty Agreement; rather, the Guaranty Agreement should contain a cross-reference to the Environmental Indemnity Agreement as the exclusive remedy for environmental claims. This avoids potential inconsistencies between the two documents and prevents the Lender from asserting duplicative claims under both instruments.
(b) Cap on Loss Carve-Out Liability. The borrower may wish to request a cap on the Guarantor's aggregate liability under the "loss" carve-outs (excluding full-recourse trigger events) at twenty to twenty-five percent (20–25%) of the original principal amount of the loan, resulting in a cap of $48,000,000 to $60,000,000. We recognize that a loss carve-out cap is not universally accepted in CMBS transactions, and certain rating agencies and B-piece buyers may resist this concept. However, loss carve-out caps are increasingly negotiated by institutional REIT borrowers with strong credit profiles, and the concept has gained market acceptance in recent years, particularly for portfolio loans. We recommend presenting this as a negotiation request with the understanding that it may ultimately be conceded if the Lender and its securitization partners are unwilling to accept it.
B. Financial Covenants of Guarantor
Lender's Position. The Lender's draft Guaranty Agreement requires the Guarantor to maintain the following financial covenants throughout the term of the loan:
(a) Minimum net worth (defined as total assets minus total liabilities, determined in accordance with GAAP) of not less than $750,000,000; and
(b) Minimum liquidity (defined as unrestricted cash and cash equivalents, plus availability under committed revolving credit facilities) of not less than $50,000,000.
Analysis. These covenant levels are consistent with the covenants in the existing bridge loan facility and, based on Fairwater REIT's current financial position, provide adequate headroom. As of the most recent Form 10-Q filing (for the quarter ended June 30, 2025), Fairwater REIT reported total GAAP net worth (stockholders' equity) of approximately $1.12 billion and liquidity (unrestricted cash plus undrawn revolver capacity) of approximately $175 million. Accordingly, the proposed net worth covenant represents approximately sixty-seven percent (67%) of Fairwater's current net worth, and the liquidity covenant represents approximately twenty-nine percent (29%) of current liquidity. These levels are acceptable in principle.
Recommended Modifications. We recommend the following procedural modifications:
(a) The financial covenants should be tested annually (not quarterly). Quarterly testing imposes an unnecessary compliance burden and creates the risk of a technical default due to temporary fluctuations in net worth or liquidity — for example, a reduction in net worth resulting from a mark-to-market adjustment on interest rate hedges, or a temporary reduction in liquidity resulting from a large property acquisition that is funded in advance of permanent financing.
(b) Compliance should be measured based on the Guarantor's public financial statements (Annual Report on Form 10-K and Quarterly Reports on Form 10-Q), as filed with the SEC. The borrower should not be required to prepare separate financial covenant compliance certificates or calculations.
(c) A thirty (30)-day cure period should apply for any failure to satisfy the minimum net worth or liquidity covenants. During the cure period, the Guarantor should have the opportunity to restore compliance (e.g., through asset sales, equity issuances, or other liquidity-generating transactions) before the failure constitutes a default under the Guaranty Agreement.
C. Successor Guarantor Provisions
Lender's Position. The Lender's draft Guaranty Agreement does not address the possibility of a successor guarantor assuming the Guarantor's obligations in connection with a merger, consolidation, or reorganization of Fairwater REIT.
Recommended Position. We recommend the inclusion of a provision expressly permitting a successor entity resulting from a merger, consolidation, or corporate reorganization of Fairwater REIT to assume the Guarantor's obligations under the Guaranty Agreement, provided that the successor entity:
(a) Has a net worth equal to or greater than the net worth of Fairwater REIT immediately prior to the merger or reorganization;
(b) Has an investment-grade credit rating (if applicable) or, if unrated, has a credit profile that is at least equivalent to that of Fairwater REIT;
(c) Assumes all obligations of Fairwater REIT under the Guaranty Agreement by written assumption agreement in form reasonably acceptable to the Lender; and
(d) Delivers updated legal opinions and such other documents as the Lender may reasonably require.
This provision is important for Fairwater REIT's long-term strategic flexibility. REIT organizational structures evolve over time through mergers, acquisitions, and internal reorganizations. Without a successor guarantor provision, any change in the corporate structure of the Guarantor could constitute a technical default under the Guaranty Agreement, even if the successor entity is larger, more creditworthy, and better capitalized than the original Guarantor.
IV. ENVIRONMENTAL INDEMNITY AGREEMENT — OPEN ISSUES
A. Scope of Indemnification
Lender's Position. The Lender's draft Environmental Indemnity Agreement provides broad indemnification from the Co-Borrowers and the Guarantor for all "Environmental Losses," which are defined to include:
(a) Costs and expenses of investigation, remediation, and cleanup of any hazardous materials on, under, or migrating from the properties;