One of the most important distinctions on a loan term sheet in commercial real estate is whether there is any “Recourse” on the loan. If you’re looking to take out a loan on a commercial property and you’re not familiar with how Recourse works, or you need a refresher, read on.
Recourse determines if a borrower is personally liable to pay back a property loan. Typically, if a property-backed loan defaults, the first piece of collateral is the land and building itself, which the lender can foreclose for sale, or otherwise transfer to another party. However, if the outstanding loan amount is still not covered after the lender seizes the property, the left-over amount can be recuperated through Recourse.
Full Recourse loans place the full amount of the loan principal, interest, and related fees on the sponsor (sponsor = borrower) in the case of a default. Full recourse loans are typically quoted by lenders in a situation of higher perceived risk — such as a construction loan or a less experienced sponsor.
Limited Recourse refers to any situation where the sponsor is liable for the outstanding loan amount upon payment default, but for some amount less than the full size of the loan.
Non-Recourse loans limit a sponsor’s liability upon default to only the stated Loan Collateral (typically the property itself, and sometimes additionally another property owned by the same sponsor). In this situation, the sponsor’s separate assets and wealth are protected if the real estate deal goes badly, except for…
The commercial real estate industry has developed a set of standard “carve-outs” for non-recourse loans, by which a lender may still seek to collect from the borrower upon default. These pertain to situations like fraud, where the borrower seeks to take advantage of the lender and walk away with money from the loan. Even with a “non-recourse” option, the lender is generally able to invoke these carve-outs in a standard set of loan documents to seek loan proceeds and damages if there is any intentional wrong-doing on behalf of the sponsor. These provisions are sometimes referred to as standard “bad-boy” carve-outs.
Banks and non-bank lenders will both issue loan quotes with or without Recourse provisions depending on the borrower’s particular situation. It’s always prudent to interact with a few lenders before selecting a loan for your real estate investment. If you need help figuring out who will lend and provide the best terms on your particular real estate investment, StackSource can match your loan request to lenders for free.