Recourse vs. Non-Recourse Commercial Real Estate Loans
When obtaining a loan to acquire or refinance commercial real estate, it may seem like there is an endless supply of features – i.e., loan terms – to choose from. Don’t be overwhelmed. This is a good problem to have. The right lender will work with you to craft financing that fits your specific business strategy like a glove. One of the first decisions you’ll need to make is whether to pursue a recourse or non-recourse loan.
Recourse and Non-Recourse Financing Options
The difference between recourse and non-recourse financing becomes apparent during a default, which, of course is an event all real estate owners hope to avoid. In the event of a default on a non-recourse commercial real estate loan, lenders can only recoup on the pledged loan collateral (the real estate itself). If the foreclosure sale of that real estate falls short of the unpaid loan principal, the borrower’s personal assets and liability are protected by that non-recourse loan term.
This protection does not exist with a recourse loan, when the lender can claim money owed in addition to the pledged collateral during the event of a default. If the lender forecloses and forces the sale of the loan collateral, and sale proceeds fall short of the unpaid loan principal, the lender then has ‘recourse’ to additional assets owned by the borrower.
Advantages of Each Loan Type
On the surface, non-recourse seems like the obvious choice for borrowers as it limits personal liability. The fact the Fannie Mae and Freddie Mac multifamily loans are non-recourse is part of the reason that so many borrowers seek agency financing. However, because non-recourse loans carry more risk for the lender, there is often stricter underwriting criteria and less flexibility in structuring the other loan terms. Non-recourse loans also typically feature a longer loan term, meaning they may not be ideal for all investment strategies.
Commercial real estate financing from banks typically comes in the form of a recourse loan. Borrowers with a long-standing relationship with their bank may find that a recourse loan reaches the closing table faster. If you are looking for a bank loan to fund a short hold strategy – say a quick renovation and re-positioning with an exit less than three years from purchase – you are probably going to need to settle on a recourse loan due to increased risk compared a long-term hold strategy. That being said, certain non-depository institutions (such as Proprietary Lending) offer short-term non-recourse bridge loans off their balance sheet.
Understanding the Limits of Non-Recourse
It’s also important to understand that lenders can seek recourse on non-recourse loans. Most non-recourse loans feature a series of carve-outs (sometimes referred to as ‘bad boy’ acts) that give the lender the ability to seek recourse. Standard carve outs are disclosed in the loan documentation, and typically include things like fraud, misrepresentation, criminal acts that result in a property’s seizure, or obtaining additional financing without notifying your primary lender.
Borrowers should always review their loan documents closely with their legal counsel to understand the terms of their recourse or non-recourse loan. Your loan originator can also serve as a helpful point of contact for any questions about how specific terms may or may not best support your investment strategy.
If you’re interested in obtaining non-recourse financing for your next commercial real estate transactions, be sure to contact a representative at Aspire Capital or request a quote today.