Recipe for a Non-recourse Loan
All else equal, every borrower would prefer a non-recourse loan. It’s a great value proposition to take a lender’s money, and pledge none of your own (besides the equity in the deal) in case things don’t work out as envisioned.
But the majority of commercial real estate loans come with recourse, especially on the smaller end. It’s a safer value proposition for the lender to have the borrower’s personal assets as a backstop in addition to the real estate collateral.
So what does the borrower need to cook up that non-recourse loan offer?
Ingredients for a non-recourse deal
A strong deal for a commercial real estate lender is all about compensation for risk. A non-recourse loan is somewhat riskier for a lender than a recourse loan, so they’ll typically be looking for either higher or safer returns to compensate.
Strong experience as a real estate investor makes the lender’s value proposition less risky. Experience will be judged against the project at hand — if it’s a ground-up development project, has the sponsor built an asset from the ground up before? Have they already owned the same asset class successfully? Do they have a track record in that geographic market? The more experience points, the better.
Strength of Market
Besides the investor, the geographic market provides additional context for a lender’s risk. One of the key risks in commercial real estate is vacancy due to a tenant moving out. If a property falls vacant, a “strong market” will have more potential replacement tenants, and hence less risk. That’s why a lender will prefer to lend recourse in weaker markets.
The higher the leverage, the higher the risk for the lender. On lower leverage deals, the additional equity acts as a buffer to the lender’s principal, protecting them from potential losses in the event of reduced income.
Pricing (rate and fees)
This is the only ingredient that will actually make the deal more lucrative for the lender, while all the others reduce their risk. While experience and a strong market can increase the borrower’s returns, they don’t increase the lender’s returns. Only increasing the loan rate and fees will make the deal more attractive to deploy more capital, all else equal.
Finding the Non-recourse lender
Have all the right ingredients above? Next you’ll need to find a lender that can offer non-recourse terms. Many local banks and credit unions cannot offer non-recourse loans, no matter the strength of the deal. Other lenders, like Fannie Mae, Freddie Mac, and the CMBS market, exclusively offer non-recourse for any loans originated. Most lenders are somewhere in-between; you can describe them as “selective” in giving out non-recourse loans.
Selectively non-recourse lenders will weigh the various factors above, and want the right combination to make the deal work for them. If they typically lend at up to 75% for recourse loans, perhaps they’ll drop their maximum LTV to 65% for non-recourse. Some will give the same leverage, but will price the loan 20–100 basis points (0.2%-1%) higher on the rate for non-recourse where applicable. Partial recourse (a percentage of the loan) may be another possibility to find middle ground. Each lender has a model they follow in order to generate the right combination of loan sizing, pricing, and terms. Some basic guidance on the types of lenders that lend non-recourse below, with the most likely to lend non-recourse coming first:
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