February 19, 2018
By Terry Painter, Mortgage Banker
Member of the Forbes Real Estate Council
Author: The Encyclopedia of Commercial Real Estate Advice – a WILEY book – OUT NOW!
So you're applying for a commercial real estate loan and you are told "this is a recourse loan." What is recourse? Is this good or bad? Does this matter? Do you have a choice? Yes, it does matter. Often borrowers do not realize when they apply for an investment property or business loan, that if they default on the loan they can lose more than the real estate or equipment that is collateralizing the financing. The loan documents for a recourse loan have a personal guarantee, which enables the lender in the event of a default to legally go after anything you own. This is beyond the collateral you might have put up for the loan. In consumer financing (non-business or investment property financing), most of the loans you have likely taken out have been recourse. If these loans are made to you personally, (your name is listed as borrower) – home loans, auto, credit card and personal loans, then you have probably taken out a recourse loan. It might be surprising that most business loans and investment property loans are also recourse. It is unlikely that you can bargain with the lender on the recourse of your loan. Sometimes you can get the lender to give you non-recourse if the LTV is 50% or under.
For the purpose of this article, when we are talking about recourse, we are referring to recourse loans in the commercial real estate industry. Even though our topic has to do with recourse loans, it is essential that you understand a recourse loan’s opposite – non-recourse loans in order to more fully understand what a recourse loan is. At Apartment Loan Store we have been making non-recourse loans that do not require a personal guarantee since 1997. Call us today to find out if you qualify for a non-recourse loan or for any further questions.
So what is a Recourse Loan?
A recourse loan is the type of loan in which the borrower is liable personally for paying back the loan balance if there is a foreclosure by the lender. This means that the lender can obtain a deficiency judgment against you, which can be levied by the court against your personal assets. If this sounds scary, it truly is. If the collateral for the property is liquidated by the lender after foreclosure and the property is sold for less than what is owed on it, including back payments and attorney fees, the lender may go after your cash or even your home to pay the deficiency. Other levied assets could include your personal bank accounts, your residence, your autos, and even your boat or RV. Retirement accounts are protected.
Commercial or Business Property Construction Loans and mini-perm loans which get short term commercial financing, it is common place for these to be full recourse loans.
What is a Non-Recourse Loan
A non-recourse loan is a type of loan in which the borrower has no personal liability regarding paying back the loan balance in the case of a default. Therefore, the lender cannot obtain a deficiency judgment against the borrower personally. These loans are vested in a single asset ownership entity like an LLC, LP, General Partnership or Corporation, not the borrowers personal name. In case of default the lender can only go after the subject property. Permanent commercial loans, some commercial construction and bridge loans are where you will typically find non-recourse loans.
But, concerning non-recourse loans, there is a common misconception ,and that is that the borrower will never be liable personally. This is not always the case—there are some exceptions. These exceptions come under what is called the Bad Boy Carve Outs. Almost all non-recourse loans have the borrower sign for these.
The purpose of the bad boy carve outs is to give protection to the lender, granting personal recourse if one or more of these things occur:
1. When fraud is committed. The borrower misrepresents the property or personal income.
2. If the borrower allows the insurance to lapse or purposely purchase insurance that does not meet the lenders requirements.
3. Not making the property tax payments
4. Doing something criminal on the property
5. Declaring bankruptcy on the single asset entity which owns the property
6. Taking an action that is contrary to the environmental indemnification
7. Not allowing Lender Inspections
An Example, Illustrating Recourse Vs. Non-Recourse Loans:
Let’s say that a borrower has an apartment complex and half of the tenants are military, and 60% are deployed because of a military crisis. Now vacancies are causing the property to run at a loss. At the same time there is an economic downturn and market rate rentals drop quite a bit. The result is that due to no fault of the borrower, the borrower cannot make payments and the property is foreclosed on. Let’s also say that the borrower has a loan balance of $2,000,000 and the property has dropped in value to $1,600,000 because of the low occupancy and lower rents. Let’s also say that on his personal financial statement he shows a net worth of $4,500,000, $450,000 of which is in cash. Now, if this is a recourse loan and if the lender is $400,000 short on paying off the $2,000,000 owed on the property when the lender liquidates the collateral they can get a deficiency judgment and get a court order to take the $400,000 out of the borrowers bank account.
What happens if the borrower has a non-recourse loan? In this case the lender will simply take the property back. The lender cannot touch the borrowers personal assets.
As long as you know yourself to be an honest, meticulous person, there is no need to worry about the bad-boy carve outs. It is important that you have an experienced real estate attorney review your loan documents prior to signing them. If your attorney does not have experience with non-recourse loans they might mistake the bad-boy carve out document for recourse and tell you that the lender has misrepresented the loan – that they have told you that it is a non-recourse loan when it is not. An experienced real estate attorney will not make this mistake.
By Terry Painter/President Apartment Loan Store and Business Loan Store