What are Non Recourse Loans?
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What is a Non Recourse Loan?
When a commercial loan product is non recourse, it renders the borrower not personally liable if they default on their loan. This keeps the personal financial assets of the borrower safe from repossession. In lieu of this, the lender is only able to repossess and sell the collateral property in order to recoup their losses.
Non-recourse loans stand opposite of recourse loans, which do allow a lender to go after a borrower’s personal property, seize it, and sell it. In most cases bank loans, mini perm loans, and commercial construction loans tend to be recourse loans, while CMBS loans, Fannie Mae® and Freddie Mac® multifamily loans, mezzanine financing, [life company loans](), and HUD® multifamily financing are all typically non-recourse financial instruments.
Recourse vs. Non Recourse Loans
A recourse financial instrument requires the personal guarantee of the borrower(s). This means that in the event of a default on the loan, if the lender is not able to recoup their full investment from the sale of the collateral property, they are allowed to seek the personal assets of the borrower for the remainder of the funds to recoup the loss in full.
With non-recourse commercial loans, however, the sale of the property itself (and/or the income the property generates) is the bank’s only way to recoup lost investment and yield in the event of a default. Non recourse loans are an obvious advantage for borrowers, because they provide incredibly less risk and exposure. Inherently, non-recourse loans carry significantly higher risks for lenders and investors, but are vastly popular loan vehicles and thus are heavily sought after and preferred by most clients.
Qualifying for Non-Recourse Financing
In order to mitigate the increased risk of non-recourse financing, commercial lenders often have strict eligibility requirements. Most non recourse programs can only be utilized for the financing of certain property types and classes. For example, a borrower might find it much easier to secure non recourse financing for a class A office or multifamily property in a major MSA (i.e. New York or Los Angeles), while a class B retail property in a small market is likely to not qualify for non recourse lending. The income that a commercial property produces (both past and present) is also a determining factor. Additionally, lenders tend to analyze the requested amount of leverage.
Non-recourse commercial mortgage loans tend to have higher interest rates than their recourse counterparts, and are also generally only available to borrowers that have a very strong financial profile. Lenders can be pretty strict about this, the thought process being that a default is significantly less likely in this scenario because the borrower has the financial means to make sure that the property’s income is reinvested into the property. Aside from strong finances, commercial mortgage lenders also require a very experienced borrower with ample "skin in the game" for non-recourse financing.
Non-Recourse Loan Burn-Offs
In some cases a recourse loan will convert into a non-recourse loan if the property is able to meet certain conditions. For example, if a property has only 75% occupancy, but the new owner is believed to have superior management skills or is known to have a portfolio of comparable properties operating successfully at a profit, a lender may issue recourse financing that converts into non-recourse financing if the property reaches 90% occupancy over a specified period of time (typically 3 months). In addition to such stipulations, the property may also have to hit a certain debt service coverage ratio (DSCR) for the same period of time.
This type of recourse financial instrument is known as a burn-off, since the recourse “burns off” when the target metrics are reached. Burn-offs are a common type of financing for commercial construction loans, given that fully non-recourse financing can be extremely risky for a lender to issue when a property does not yet have any income.
Non-Recourse Debt and Bad Boy Carve Outs
While non-recourse loans are harder to get, they are very much the standard loan type in the market of commercial loans over $5–$10 million. Even so, most non-recourse loans come with some standard bad boy carve-outs, which allow the lender to pursue full recourse if the borrower is found to be negligent or participating in anything fraudulent. Fraudulent activity in this scenario includes (but is not limited to) the borrower materially misrepresenting their financial health to the lender, intentionally declaring bankruptcy, failing to pay property taxes, or failing to maintain the required insurance coverage. Essentially, the purpose of these carve-outs is to quickly convert a non-recourse mortgage loan into a full-recourse loan in order to protect the lender from loss die to ill-intention.
Related Questions
What are the benefits of a non-recourse loan for commercial real estate?
The primary benefit of non-recourse loans is that they provide a greater degree of protection for the borrower. Without a personal guarantee, the lender cannot seize the borrower's personal assets if they default on the loan. This can be especially beneficial for developers who are just starting out and don't have a lot of assets to protect.
Other benefits of non-recourse loans include:
- Investors can significantly increase their returns by taking on greater risks
- The terms of a non-recourse loan allow borrowers more flexibility when negotiating deals
- Non-recourse loans provide peace of mind during times of uncertainty, such as market fluctuations or economic downturns
- Borrowers can borrow more, as the debt isn’t tied to the borrower’s income or total assets
- Non-recourse loans can be significantly less complicated for a syndication or partnership
What are the risks associated with non-recourse loans?
The main risks associated with non-recourse loans are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk. This typically makes non-recourse financing more expensive.
Another potential risk is tied to exceptions to the non-recourse clause in the loan. While it’s true that a lender generally cannot pursue a borrower’s personal assets or income outside of the property itself, most non-recourse loans include language for what are known as bad boy carve-outs. These provisions essentially state that, should the borrower misrepresent a property or themselves, or file fraudulent financial documents — like tax returns or financial statements — the borrower is no longer protected by the non-recourse clause and is fully responsible for the loan. They may also cover other acts, such as raising subordinate financing when it’s not allowed, or even paying real estate taxes late.
What types of commercial real estate properties are eligible for non-recourse loans?
Non-recourse loans typically only accept certain property types and classes for financing. For example, a Class A office or multifamily property in a major MSA (i.e., New York or Los Angeles) may easily get a non-recourse loan, while a Class B retail property in a tertiary market is unlikely to qualify. Source
Lenders will typically set more stringent debt service coverage ratio requirements and may cap leverage at a certain amount, as well. Source
Most non recourse programs can only be utilized for the financing of certain property types and classes. For example, a borrower might find it much easier to secure non recourse financing for a class A office or multifamily property in a major MSA (i.e. New York or Los Angeles), while a class B retail property in a small market is likely to not qualify for non recourse lending. Source
What are the requirements for obtaining a non-recourse loan?
In order to qualify for a non-recourse loan, commercial lenders often have strict eligibility requirements. Most non-recourse programs can only be utilized for the financing of certain property types and classes. For example, a borrower might find it much easier to secure non-recourse financing for a class A office or multifamily property in a major MSA (i.e. New York or Los Angeles), while a class B retail property in a small market is likely to not qualify for non-recourse lending. The income that a commercial property produces (both past and present) is also a determining factor. Additionally, lenders tend to analyze the requested amount of leverage.
Non-recourse commercial mortgage loans tend to have higher interest rates than their recourse counterparts, and are also generally only available to borrowers that have a very strong financial profile. Lenders can be pretty strict about this, the thought process being that a default is significantly less likely in this scenario because the borrower has the financial means to make sure that the property’s income is reinvested into the property. Aside from strong finances, commercial mortgage lenders also require a very experienced borrower with ample "skin in the game" for non-recourse financing.
What are the differences between recourse and non-recourse loans?
At its core, the difference between the two types is relatively straightforward: If a borrower defaults on a recourse loan, a lender can pursue the borrower’s personal assets — even wages — if the collateral is insufficient to cover the outstanding debt. With a nonrecourse loan, the lender is limited to the collateral itself to recoup losses.
Typically, most bank, bridge and construction loans are recourse, while Fannie® Mae®, Freddie® Mac®, HUD/FHA multifamily and CMBS loans are generally nonrecourse — though exceptions are not rare.
Because of the difference in risk to borrowers and lenders, there are some key differences in loan terms and requirements. In brief:
Recourse Loan Nonrecourse Loan Risk Profile Riskier for borrowers Riskier for lenders Default Event Lenders may pursue a borrower's personal assets Lenders may generally only pursue a loan's collateral. Borrower Profile Typically less experienced More experienced, financially stronger Interest Rate Generally lower Generally higher Asset Types Any Often restricted to "strong" assets and locations LTV Generally higher Generally lower Examples Most bank loans, bridge loans, construction loans Most Fannie Mae®, Freddie Mac®, CMBS loans While borrowers broadly prefer nonrecourse financing, lenders favor recourse loans due to lower risks. Due to this imbalance, these types of loans tend to have rather different terms associated with them.
Different Loans for Different Assets: While recourse loans are widely used for most asset classes, nonrecourse lenders are typically far more selective, generally opting to finance stronger, lower-risk properties with one eye fixed on a market’s overall strengths and outlook.
For example, the owner of a stabilized Class A multifamily property in Manhattan may have little trouble landing a nonrecourse loan, but a first-time investor seeking a hotel refinance in suburban Boise, Idaho, would likely have little choice but to look to recourse financing.
Recourse loans require the personal guarantee of the borrower(s) so that in the event of loan default if the bank doesn't recoup their full investment from selling the property, the borrower and their personal assets are on the line for the remainder of the funds to make the bank whole.
In the case of non-recourse commercial loans, the bank’s only way to recoup lost investment and yield in the event of a default is through the property itself and the income the property generates. This is obviously an advantage for borrowers, because who wouldn’t want less risk and exposure? Conversely, non-recourse loans carry significantly higher risks for lenders and investors.