One of the most important decisions you’ll make as a commercial real estate investor is determining how to structure your borrowing. Commercial real estate investors usually have two types of loan financing options: recourse debt and non-recourse debt.

Recourse Debt

Most property investors are familiar with recourse debt, which are the type of loans commercial banks generally offer. The lender owes the investor a sum of money to put towards a property purchase or investment. That lender is then guaranteed the right to collect the difference if the property is later sold for less than the amount owed.

According to the terms of a recourse loan, if the investor borrows $3 million from a commercial bank, has paid it down to $2.75 million by the time the property is sold, but is only able to sell the property for $2.25 million, the investor is required to pay the bank back the $500,00 difference. Similarly, if the investor defaults on the loan, the lender can liquidate the collateral property and demand any balance after that sale.

Nonrecourse Debt

Like recourse debt, nonrecourse debt is a loan in which collateral, the property, is used as security. These loans differ because the lender can only be compensated by the liquidation of the collateral. The borrower has no personal liability to make up the debt difference, if there is one, after the sale of a property.

Because non-recourse debt is, by nature, riskier to the lender, these types of loans are more often offered by commercial mortgage-backed securities (CMBS) and life-insurance companies than by commercial banks. CMBS lenders pool the amounts from their mortgages to secure as bonds to be sold on the open market.

The advantage of nonrecourse loans to the investor is clear: the elimination of personal liability in cases when the property sells for less than is owed. There are more restrictions in nonrecourse loans, though, which generally have less flexibility in structure and pricing. Nonrecourse loans are more often offered at fixed rates than floating rates.

Investors who choose to fund their properties through nonrecourse loans can also avoid all of the full financial disclosures that are required by lenders of recourse loans. Because the nonrecourse lender is securing the loan on the value of the collateral solely, the financial relationship with the individual lender is not as critical to the process.

Lenders do put themselves at a greater risk when offering nonrecourse loans, so they can include requirements to protect themselves against that risk. A nonrecourse loan may require escrow and impound accounts, and arrangements for rent payments. This allows the lender to more closely scrutinize the property’s cash flow and operations in order to make sure that the property maintains its value.

Nonrecourse debt lenders may also put additional restrictions on prepaying the loan before it matures, and require early termination amounts.

Investors who plan on holding their property for the duration of the loan, though, and who are comfortable with additional requirements on property cash flow and maintenance should consider nonrecourse loans as a way to decrease their personal liability for repayment.

 

Leave a Reply

Your email address will not be published. Required fields are marked *