Is Non-Recourse Financing Right for You?
There are plenty of advantages and disadvantages that come with non-recourse financing for your commercial real estate property. Find out if this type of loan fits your needs.
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If you’re looking to finance your next industrial real estate acquisition or refinance your multifamily community, you will want to consider an important aspect of your loan: whether or not it’s recourse or non-recourse.
Every single loan is either recourse or non-recourse. A recourse loan is what you probably think of for most car or home loans. In the case of a car, the vehicle is used as collateral should you default. But, if the car’s value isn’t enough to cover the loan balance, the lender can go after your other assets to make up the difference.
A non-recourse loan is a loan where the borrower is not personally liable for repayment. This means that if the borrower defaults, the lender can only collect from the property itself, not from the borrower's other assets. This offers a significant advantage to the borrower. Even if a lender forecloses on a property, it likely will not even impact the defaulting borrower’s credit score.
This article examines the pros — and cons — of non-recourse debt. Have any questions about which type of financing is right for you? Fill out the form below, and we’ll be in touch to discuss your options.
Are Most Commercial Real Estate Loans Non-Recourse?
No, most commercial real estate loans are not non-recourse. Many lenders are willing to structure loans as non-recourse, but a borrower must meet certain conditions, due to the lender’s increased risk. These can range from higher credit scores to more experience in commercial real estate investing. Similarly, properties are also subject to more scrutiny. Lenders will typically set more stringent debt service coverage ratio requirements and may cap leverage at a certain amount, as well.
Advantages of Non-Recourse Loans for Borrowers
The main advantage of a non-recourse loan for borrowers is the lack of any personal liability. If a loan defaults, the borrower can effectively walk away, after all.
Another advantage of a non-recourse loan is that it can enable an investor to borrow more. This is because the debt isn’t tied to the borrower’s income or total assets — as they aren’t involved in non-recourse financing. With recourse debt, banks and other lenders can place a cap on how much debt they can accept, relative to an investor’s personal income.
Finally, non-recourse loans can be significantly less complicated for a syndication or partnership. Consider the challenges of recourse financing in such a situation: Let’s say three investors pool their resources to finance the acquisition of a shopping center. Which of the three should be willing to put their personal finances on the hook, should the investment go south? Would you do it?
Disadvantages of Non-Recourse Loans for Borrowers
The main disadvantages of a non-recourse loan are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk.
This typically makes non-recourse financing more expensive. Essentially, borrowers of non-recourse debt are paying the lender to shift the debt burden to the bank, credit union, life insurance company, or other lender.
Another potential disadvantage is tied to exceptions to the non-recourse clause in the loan. While it’s true that a lender generally cannot pursue a borrower’s personal assets or income outside of the property itself, most non-recourse loans include language for what are known as bad boy carve-outs.
These provisions essentially state that, should the borrower misrepresent a property or themselves, or file fraudulent financial documents — like tax returns or financial statements — the borrower is no longer protected by the non-recourse clause and is fully responsible for the loan. They may also cover other acts, such as raising subordinate financing when it’s not allowed, or even paying real estate taxes late.
The Conclusion
The truth is, there’s no clear-cut answer to if a non-recourse loan is a better solution to your commercial real estate financing needs. The reality is that every situation and borrower is different, and what works for you in one investment may not work for you in another.
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Related Questions
What are the benefits of non-recourse financing?
The primary benefit of non-recourse loans is that they provide a greater degree of protection for the borrower. Without a personal guarantee, the lender cannot seize the borrower's personal assets if they default on the loan. This can be especially beneficial for developers who are just starting out and don't have a lot of assets to protect.
Advantages of Non-Recourse Loans for Borrowers include the lack of any personal liability, the ability to borrow more, and the potential for less complicated syndication or partnership.
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What types of commercial real estate projects are best suited for non-recourse financing?
Non-recourse financing is typically only available for certain property types and classes, such as Class A office or multifamily properties in major MSAs (i.e., New York or Los Angeles). Property income, both past and present, is also a determining factor, as well as the requested amount of leverage. In general, non-recourse loans typically have a higher interest rate than their recourse counterparts. Commercial mortgage lenders will also require a very experienced borrower for making a non-recourse loan.
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What are the risks associated with non-recourse financing?
The main risks associated with non-recourse financing are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk. This typically makes non-recourse financing more expensive.
Another potential risk is tied to exceptions to the non-recourse clause in the loan. While it’s true that a lender generally cannot pursue a borrower’s personal assets or income outside of the property itself, most non-recourse loans include language for what are known as bad boy carve-outs. These provisions essentially state that, should the borrower misrepresent a property or themselves, or file fraudulent financial documents — like tax returns or financial statements — the borrower is no longer protected by the non-recourse clause and is fully responsible for the loan. They may also cover other acts, such as raising subordinate financing when it’s not allowed, or even paying real estate taxes late.
What are the requirements for obtaining non-recourse financing?
In order to qualify for non-recourse financing, commercial lenders often have strict eligibility requirements. Most non-recourse programs can only be utilized for the financing of certain property types and classes, such as class A office or multifamily properties in major MSAs (i.e. New York or Los Angeles). The income that a commercial property produces (both past and present) is also a determining factor. Additionally, lenders tend to analyze the requested amount of leverage. Non-recourse commercial mortgage loans tend to have higher interest rates than their recourse counterparts, and are also generally only available to borrowers that have a very strong financial profile. Lenders can be pretty strict about this, the thought process being that a default is significantly less likely in this scenario because the borrower has the financial means to make sure that the property’s income is reinvested into the property. Aside from strong finances, commercial mortgage lenders also require a very experienced borrower with ample "skin in the game" for non-recourse financing. Additionally, lenders will typically set more stringent debt service coverage ratio requirements and may cap leverage at a certain amount.
What are the differences between recourse and non-recourse financing?
At its core, the difference between the two types is relatively straightforward: If a borrower defaults on a recourse loan, a lender can pursue the borrower’s personal assets — even wages — if the collateral is insufficient to cover the outstanding debt. With a nonrecourse loan, the lender is limited to the collateral itself to recoup losses.
Typically, most bank, bridge and construction loans are recourse, while Fannie® Mae®, Freddie® Mac®, HUD/FHA multifamily and CMBS loans are generally nonrecourse — though exceptions are not rare.
Because of the difference in risk to borrowers and lenders, there are some key differences in loan terms and requirements. In brief:
Recourse Loan Nonrecourse Loan Risk Profile Riskier for borrowers Riskier for lenders Default Event Lenders may pursue a borrower's personal assets Lenders may generally only pursue a loan's collateral. Borrower Profile Typically less experienced More experienced, financially stronger Interest Rate Generally lower Generally higher Asset Types Any Often restricted to "strong" assets and locations LTV Generally higher Generally lower Examples Most bank loans, bridge loans, construction loans Most Fannie Mae®, Freddie Mac®, CMBS loans While borrowers broadly prefer nonrecourse financing, lenders favor recourse loans due to lower risks. Due to this imbalance, these types of loans tend to have rather different terms associated with them.
Different Loans for Different Assets: While recourse loans are widely used for most asset classes, nonrecourse lenders are typically far more selective, generally opting to finance stronger, lower-risk properties with one eye fixed on a market’s overall strengths and outlook.
For example, the owner of a stabilized Class A multifamily property in Manhattan may have little trouble landing a nonrecourse loan, but a first-time investor seeking a hotel refinance in suburban Boise, Idaho, would likely have little choice but to look to recourse financing.
What are the advantages and disadvantages of non-recourse financing?
The main advantage of a non-recourse loan for borrowers is the lack of any personal liability. If a loan defaults, the borrower can effectively walk away, after all. Another advantage of a non-recourse loan is that it can enable an investor to borrow more. This is because the debt isn’t tied to the borrower’s income or total assets — as they aren’t involved in non-recourse financing. With recourse debt, banks and other lenders can place a cap on how much debt they can accept, relative to an investor’s personal income. Finally, non-recourse loans can be significantly less complicated for a syndication or partnership.
The main disadvantages of a non-recourse loan are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk. This typically makes non-recourse financing more expensive. Essentially, borrowers of non-recourse debt are paying the lender to shift the debt burden to the bank, credit union, life insurance company, or other lender.
Another potential disadvantage is tied to exceptions to the non-recourse clause in the loan. While it’s true that a lender generally cannot pursue a borrower’s personal assets or income outside of the property itself, most non-recourse loans include language for what are known as bad boy carve-outs. These provisions essentially state that, should the borrower misrepresent a property or themselves, or file fraudulent financial documents — like tax returns or financial statements — the borrower is no longer protected by the non-recourse clause and is fully responsible for the loan. They may also cover other acts, such as raising subordinate financing when it’s not allowed, or even paying real estate taxes late.