Years ago, no one would have dreamed of not being responsible for a loan by signing on the bottom line. It was a sign of commitment, often followed by a firm handshake while looking the banker directly in the eye. Fast forward to modern day banking and it is commonplace for many borrowers to expect and, surprisingly, demand a non-recourse loan. While the intent behind it is to lessen the severity of impact should there be another financial crisis, borrowers should understand that the property itself must be worthy of the request.
While non-recourse lending sounds like a great idea at the onset, it carries its own set of baggage and pitfalls. Although it means you are not held personally liable should the property fall into default, it does not offer some of the perks of its seemingly less attractive counterpart, the full recourse loan.
Non-recourse lending requires the borrower to have a strong PFS (personal financial statement). Now, that may seem contrary to the very idea of not holding personal guarantee on a loan; however, when you look at it from the lender’s perspective, it makes a lot of sense. If the lender is not requiring the borrower to be personally liable, they need some sense of who the borrower is and if they have the financial wherewithal to even be asking for non-recourse lending. A poor financial statement with little liquidity and equity in other properties can be problematic. Why would a lender risk lending millions of dollars off their balance sheet with no personal liability to someone who has limited, if any, additional resources? The answer is simple…they wouldn’t.
A strong, industry relevant resume is also key to procuring a non-recourse loan. If the borrower does not have a successful track record within the industry, the lender is not likely to offer a loan with no personal recourse. If they have years of experience running the same property type they are requesting a loan for, then it is clear that they know what they are doing and will succeed in running the additional property, thereby making timely payments on the loan.
Oftentimes, corporate entities are formed with 10 or more members, none of whom have the requisite 20% or more equity in the property that is an industry standard for lending. These types of capital groups often request limited or non-recourse lending. Depending on the DSCR (debt service coverage ratio) of the subject property, it can be difficult to get non-recourse lending. The property would have to have an exemplary track record of income and lease up containing few, if any, vacancies.
Lenders offer non-recourse lending on many commercial property types given the property is in a great location, in good condition and has strong occupancy in a well populated area. Do not count on financing a property with a non-recourse loan if it and you are not an experienced operator. Even with a professional management company, non-recourse loans are not won strictly on the basis of property performance.
Another thing to remember is that non-recourse lending typically carries a lower LTV (loan to value) thereby limiting how much you can borrow against the property. Where a full recourse loan may offer as high as 90% LTV, its non-recourse counterpart is maxed at merely 65-70%, unless the borrower has a large portfolio of like performing properties. This is the risk vs. reward aspect of lending a full recourse vs. non-recourse loan. It’s less of a risk for the bank to have a signed guarantee thereby allowing a higher LTV than it is to have no accountability on a non-recourse product, therefore offering a lower LTV.
There are exceptions to the likelihood that even if a full recourse loan would go into default, you would then be held accountable. It’s called a single action state. Both California and Arizona hold this law but it is best to check with your local government to confirm. A single action state is one in which, should you default on the loan, the lender can only pursue either the property or the owner, not both. So let’s say you have not made a payment in months and the bank forecloses on the property and the property is worth $5,000,000.00 but you only owed $2,000,000.00, the bank would take a ‘single action’ and only take the property back but not pursue you for the balance because there is sufficient equity in the property to recover the loss. Now, here’s the flip side of that. Let’s say you owe $5,000,000.00 to the bank because prior to the recession, they provided additional capital for expansion and improvements but the value of the property had dropped to $4,000,000.00. Then you may have a problem, especially if you hold other assets or liquidity that could make the bank whole again given the shortfall on the subject asset.
Consider this, if you don’t believe enough in the property to sign on the bottom line with your personal guarantee, why are you buying or refinancing it at all? Oftentimes borrowers say they just don’t want to be liable if it doesn’t work out. To lenders, that’s a red flag at the onset and oftentimes an indicator that there is an innate issue with the property or the borrower.