- How Does Cross Collateralization Work?
- Advantages of Cross Collateralization in Commercial Real Estate
- Lower Interest Rates
- Larger Loan Amounts
- Advantageous Debt Consolidation
- Disadvantages of Cross Collateralization in Commercial Real Estate
- More Collateral, More Risk
- Extra Administrative Hassle, Costs
- Complications for Your Exit Strategy
- Is Cross Collateralization Right for You?
- Related questions
- Get Financing
Cross collateralization is a common practice in commercial real estate lending. In a cross-collateralized loan, the borrower pledges more than one property as collateral for a loan. This can provide the lender with greater security for the loan, as they have a greater value to collect if the borrower defaults on the loan.
How Does Cross Collateralization Work?
Cross collateralization is often a complex legal arrangement, so it's important to understand how it works before entering into a financing agreement with a cross-collateralization clause. Technically, cross collateralization occurs when a borrower pledges multiple assets as collateral for a single loan. The assets don’t necessarily have to be real estate — but they usually are.
The clause will be present in the loan document itself, and, while the wording may vary, it generally gives the lender the right to foreclose on any of several properties that a borrower owns and lists in the document. Note: The lender is limited to the properties specifically stated in the document.
Advantages of Cross Collateralization in Commercial Real Estate
There are some significant advantages to cross collateralization for a borrower. Most of the pros relate to beneficial loan terms. After all, adding more collateral to a loan significantly mitigates the lender’s risk.
Lower Interest Rates
Lower interest rates are a major advantage to cross-collateralized loans. This ties directly back to the lower risk to the lender — as a result, most lenders will offer rates at a considerably lower spread compared to a single-asset, non-recourse mortgage.
Larger Loan Amounts
Loan amounts can be larger, too. This is more a function of the additional value the collateral brings. If a lender would normally offer financing for your industrial property at a loan-to-value ratio of, say, 75%, adding a second asset increases the amount of financing in real terms, even if you opt for a lower LTV ratio.
Advantageous Debt Consolidation
Another key advantage of cross collateralization is how it can be used to consolidate debt. If an investor owns three properties with three different loans — each having different interest rates and term lengths — it may be advantageous to use a cross-collateralized loan to refinance the three properties under one mortgage. This not only reduces the administrative burden of handling multiple separate loan payments, but it could also result in one overall advantageous interest rate, amortization period, and term length.
Disadvantages of Cross Collateralization in Commercial Real Estate
Of course, cross collateralization has its disadvantages. And these go beyond simply the addition of other assets to a loan's collateral.
More Collateral, More Risk
Of course, let's start with the obvious: The main potential downside of a cross-collateralization clause is that if a borrower defaults on the loan, they could potentially lose more than one property. If your loan goes into foreclosure, and your primary property’s value isn’t high enough to cover the principal remaining on the mortgage, this could be incredibly costly.
Extra Administrative Hassle, Costs
Beyond this, cross collateralization also means there’s more complications in getting a loan. For every property you add as collateral, you will likely need to provide ample documentation, including rent rolls, P&L statements, and so on, for each. Additional costs may also be a factor here, as the lender will often require an appraisal of every property used as collateral.
Complications for Your Exit Strategy
Finally, cross collateralization can make it significantly more complicated to exit a single investment. Let’s say you have two retail assets tied up in a single loan. Should you wish to sell one of those properties, this may be tricky. While it’s certainly not impossible, selling a part of the collateralized portfolio would likely require the lender to either sign off on adjustments to the loan terms or that you find a buyer for all the properties encumbered by the financing.
Is Cross Collateralization Right for You?
Cross collateralization may not be the right choice for everyone. Every borrower wants the best loan terms, of course. But the risks, complications, and costs can’t be ignored. Before deciding to pursue a cross-collateralized loan, a commercial real estate investor must carefully weigh both the advantages and disadvantages.
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- What is cross collateralization?
- Cross collateralization is a common practice in commercial real estate lending. In a cross-collateralized loan, the borrower pledges more than one property as collateral for a loan. This can provide the lender with greater security for the loan, as they have a greater value to collect if the borrower defaults on the loan.
- What are the key cross-collateralization considerations for a borrower?
- Some of the key considerations for borrowers include the interest rate, the loan amount, the term length, and the investor's exit strategy for each property in the portfolio.
- How does cross collateralization work?
- Cross collateralization happens when a borrower pledges more than one asset as collateral for a loan. This can be done to secure a lower interest rate, or to get a larger loan than would be possible with just one asset.