When most real estate investors are getting started, they don’t have “hard money” for the investment. But even though you don’t have money in the bank to pay cash upfront for the investment, there are often financing options that can be leveraged. If you are looking for a loan for an investment opportunity, consider non-recourse financing for commercial real estate.
Personal Guarantee on the Loan
In most situations, a lender will ask the borrower to offer a personal guarantee on the loan that will be provided. This method of “recourse” financing means that a borrower’s personal assets might be at risk if a borrower defaults on the loan. For example, if you are unable to meet the debt payment and foreclosure happens, then the lender can leverage your personal assets to recover the lost funds.
Recourse financing (also called “full recourse”) is the most common type of loan offered by banks and private lenders for real estate purchases. But you shouldn’t always assume that your personal assets need to be on the line if you are preparing for a real estate purchase. You can find options for “non-recourse” lending that might be a better fit for your needs.
What is Non-Recourse Financing?
Finding a lender that offers a non-recourse opportunity means that you don’t need to put a personal guarantee on the loan. The lender only looks at the asset being financed as collateral for the loan. In the unlikely situation that something goes wrong with the investment, then the lender can foreclose on the property. But the use of nonrecourse debt means you don’t need to be worried about your other assets being at risk in this bankruptcy process.
The main difference between recourse and non-recourse financing is apparent if a default happens on the loan. Of course, investors and real estate owners hope that default doesn’t occur. But you always need to look at every possible outcome to determine the potential consequences on your investment and your personal assets.
The main advantage of non-recourse lending is that if the property is foreclosed and the sale falls short of the unpaid principal on the loan, then it means that your liability and personal assets are protected due to the non-recourse loan terms. In the multifamily investing world, Fannie Mae and Freddie Mac offer.
Minimizing Risk in Your Investment
As a general rule of thumb, if you are looking to minimize risk, then non-recourse financing is always a better option compared to recourse loans. There is a risk in every investment; why put other assets on the line along with the investment property? It’s smart to avoid this risk when possible.
When it comes to a real estate partnership with passive investors, non-recourse financing is essential. For example, it doesn’t make sense for one or more of the partners to offer a personal guarantee on a debt shared by the partnership. A minority partner would never guarantee the full balance of the loan. In my opinion, non-recourse financing is the perfect solution for partnerships, and an absolute necessity to protect the interests of everyone involved.
When Can a Lender Seek Recourse on a Non-Recourse Loan?
Even though you have a non-recourse loan, it doesn’t mean that the lender cannot seek recourse if the loan defaults. Caveats might be built into terms, such as:
- Property seizure due to criminal acts
- Failure to notify the primary lender when obtaining additional financing
These caveats will be disclosed fully in the loan documentation. It is important that you understand the details of the loan so that you know your personal liability if something goes wrong. Always review loan documentation with legal counsel and other financial experts.
Recourse vs. Non-Recourse Financing: What’s the Catch?
If non-recourse financing is available, then why would anyone choose a loan on a recourse basis? On the surface, it seems like a non-recourse loan is the most obvious choice for all borrowers since personal liability is limited.
You need to consider the reality that non-recourse lending means that the lender is carrying more risk in the deal. The trick is finding a lender that is willing to loan the money on a non-recourse basis. Most lenders want to have collateral available from the borrower, which means that you will likely find it more difficult to obtain financing on a non-recourse basis.
Some lenders only want to offer non-recourse financing for the highest qualified institutions. Additionally, a higher interest rate will likely be used, which means that you can likely get a better rate with a traditional, recourse loan, leading to additional cash flow. If you can find a lender willing to offer non-recourse lending, often the underwriting criteria is stricter, and there is less flexibility in the way the loan can be structured.
Additionally, most of these non-recourse loans only offer terms for a longer loan, which means that it’s not a good option if you are looking at shorter-term investment strategies. For example, if you are using a short hold strategy to renovate and then flip the property in a few short years, then you are likely going to get a recourse loan.
Be aware that some non-recourse deals are designed to take advantage of the buyer. There’s an argument that situations like Commercial Mortgage-Backed Securities (CMBS) are outright predatory to the borrower.
Finding the Right Financing Solutions for Your Investment
Most typical commercial real estate loans offered by banks are structured as recourse loans. But never assume that it is impossible to get non-recourse financing for commercial real estate. It might take a bit of work to find the lenders in your market who are willing to offer money on a non-recourse basis. Focus on building relationships and connecting with other players in the industry who can help you get the financing that fits your needs.
Once you find the right lender, you can work together to compare various loan terms and craft the financial agreement that is a perfect fit for your business strategy. If you are looking at investment options, then our team at First National Realty Partners is here to assist. Contact us at any time to learn about the various financing solutions available for your commercial real estate investment. We’re here to help!