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 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.
Contact our team by entering your details in the form below. We’ll be happy to walk you through your unique situation and strategy leveraging our deep knowledge and expertise.
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- What is the main advantage of non-recourse financing?
- The main advantage of a non-recourse loan for borrowers is the lack of any personal liability in the event of a default.
- What is the main disadvantage of a non-recourse loan?
- Non-recourse loans often have higher interest rates to account for the additional risk to the lender.
- What are some common exceptions to non-recourse clauses in a loan?
- Some exceptions to the non-recourse clause in a loan are misrepresentation of a property, filing of fraudulent financial documents, raising subordinate financing, and even becoming delinquent on real estate tax payments.