One key component of a commercial real estate deal is the financing associated with it.

While there are many different types of loan products available to lenders, all property debt tends to fall into one of two categories: recourse or non recourse loans.

In this article, we take a look at the differences between the two, and specifically, when and why CRE investors would want to use non recourse financing.

Non Recourse Financing in Commercial Real Estate

When given an option, commercial real estate investors will always opt to use non recourse financing.

Let’s look at why that’s the case.

What is non recourse financing?

In commercial real estate, the term “recourse” is really just another way to refer to a “guarantee.”

Therefore, when people talk about non recourse financing, they’re referring to loans that do not require the borrower – whether an individual or an entity, such as an LLC – to guarantee the loan.

Essentially, with a non recourse loan, the lender cannot hold the borrower or guarantors liable in the event of the default.

The collateral securing the loan (aka the real estate, including the building and land) is the sole source of repayment.

The lender can seize and sell the property, but the lender cannot go after any of the borrower’s non-pledged property or assets.

Recourse vs. Non Recourse loans

Most lenders, particularly traditional banks, want some sort of guarantee that they will be repaid in the event that a commercial real estate deal does not perform as intended.

Why most prefer recourse loans: with recourse loans, the lender has the ability to collect the difference between the sale price of the property and the amount owed on the note.

If the sale of the property is not sufficient to cover the balance owned on the note, the lender can go after the guarantor’s other assets – such as other pieces of real estate, retirement accounts, securities and more.

Some recourse loans are structured to include what’s known as an “unlimited guarantee,” which is a guarantee of full principal repayment, interest, collection costs and any related fees.

There’s some overlap between recourse and non recourse loans. This is because some loans can start as recourse loans and then convert to non recourse as the borrower achieves certain pre-determined benchmarks.

For example, a borrower may take out a loan to purchase a vacant retail center with the intent to renovate the property and then lease it up.

Because there is no cash flow currently coming in from the property, most lenders would be hesitant to make a loan on the property without some sort of recourse to an individual or company that has the financial wherewithal to pay interest on the loan or even re-pay it in full if the property does not lease up as expected.

However, a lender will often agree to remove the recourse once the property is generating a sufficient level of cash flow to cover the loan payments. In this case, the recourse “burns off” with performance at the property.

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What does non recourse financing look like in CRE?

Recourse and non recourse loans are not inherently structured differently.

Instead, think of recourse as just one of the many terms that gets negotiated into a loan agreement.

A commercial real estate investor’s ability to get non recourse financing depends on a number of factors that lenders look at when determining a borrower’s and/or project’s overall level of risk when making the loan.

These factors include:

(1) The quality of the sponsor (i.e., the individual or company that owns and is managing the deal);

(2) The amount of leverage (i.e., the loan-to-value ratio, which considers how much equity the sponsor has in the deal);

(3) The stability of the cash flows from the property, if any;

(4) The amount of construction required to build and/or renovate the property;

(5) The location of the real estate.

The lower the risk, the better chance a borrower has of getting a non recourse loan.

“Bad Boy” Carve Outs

In commercial real estate, most non recourse loans will include what’s referred to as a “bad boy” carve out. This is essentially a clause that gives the lender recourse in the event that the borrower misbehaves for some reason.

Typical bad boy carve outs include actions such as fraud, misrepresentation, waste, negligence, misappropriation, or any sort of sale, encumbrance, or transfer without the lender’s prior consent.

Bad boy carve outs have become more common in recent years, as lenders have been pressured to issue more non recourse loans. Lenders found that truly non recourse loans, absent a bad boy carve out, led to unintended consequences.

For instance, a lack of personal liability might enable, and in some instances, encourage, a distressed borrower to covertly siphon cash out of the property in the months leading up to a default.

The introduction of bad boy carve outs were intended to keep borrowers and their principals honest.

It is always important for a commercial real estate investor to understand which events will trigger limited liability vs. full recourse liability under the loan.

For instance, a typical bad boy carve out will include a provision making the borrower liable for the lender’s actual loss incurred as a result of the borrower’s commission of waste at the property.

But what constitutes “waste?”

If a tenant unexpectedly vacates a property, and the borrower uses the remaining cash flow to pay real estate taxes instead of servicing the HVAC system, and then the HVAC system stops working—should the borrower be held liable?

The borrower didn’t intentionally cause the damage to the HVAC system, they just didn’t have the funds to make repairs at that time.

Now, if the borrower was making cash distributions to its principals instead of making the repairs, then a lender might cite breach of contract.

Non Recourse Negotiations

Most commercial real estate loan terms are customized during a negotiation between the lender and the borrower.

The level of guarantee and the details are part of this negotiation. Because each deal is different, the guarantees can vary widely from deal to deal.

For example, with a construction loan, a loan is typically referred to as “non recourse” when there is no guarantee of principal repayment.

However, a construction loan will typically require the aforementioned bad boy carve out guarantee, a “completion guarantee,” and an “interest & carry guarantee.”

A completion guarantee requires an individual or company to guarantee that the proposed construction project will in fact be completed.

Consider this example…

A novice developer breaks ground on a four-story mixed-use project located in an urban area.

While digging the foundation, the developer uncovers an underground storage tank. That tank has been leaking oil for the past decade, and now the surrounding soils are contaminated.

Significant remediation is required in order for this project to move forward.

The developer realizes he has gotten in over his head, and he wants to walk away from the project.

Even though he had non recourse financing to build the project, the completion guarantee that was included makes him personally liable if he defaults on the loan since he will not have completed the project.

An interest and carry guarantee requires an individual or company to provide a guarantee that the interest and carry costs (such as real estate taxes, insurance and utilities) are paid during the construction period.

Borrowers are typically able to negotiate fewer guarantees when seeking non recourse financing for a permanent loan on a stabilized property.

In other words, when there is no construction involved and the property is already leased up and cash flowing, there is less risk involved, and therefore, the borrower will be able to get better terms on a non recourse loan.

Low-risk projects typically only have carve out guarantees.

Non Recourse Loan Rates

Loan rates on non recourse loans can vary depending on the source of the debt and the terms of the deal.

Two of the biggest sources of non recourse loans are life insurance companies and debt funds (examples below).

Debt funds are primarily real estate investment companies that have moved into the lending business.

Debt funds will typically do higher leverage, higher rate non recourse loans because they are comfortable taking over the property or constriction property if the borrower defaults on the loan.

Debt fund interest rates are typically 50 to 250 basis points more expensive on spread than traditional banks.

Let’s say a bank is lending at Libor+225, non recourse interest rates from a debt fund would start at Libor+300.

Again, the interest rates on non recourse loans are truly dependent on the deal specifics.

A high-quality sponsor looking to finance a well-located, stabilized property will get a much better interest rate on a non recourse loan than a less-experienced sponsor looking for a non recourse loan to build a ground-up development in a secondary or tertiary market.

The interest rate is directly correlated with the level of risk involved in the deal.

Why CRE Investors Use Non Recourse Financing

Commercial real estate investors will always use non recourse financing when possible. It’s like asking, “when would a commercial real estate investor use low-interest financing?”

Answer: whenever they can.

But there are some practical situations in which non recourse financing makes a deal less complicated.

For example, let’s say an investor has partnered with a lab developer to build a life sciences building on the outskirts of Los Angeles.

The developer has 25% equity in the deal; the other investor has contributed 75% of the equity.

If something with the deal goes wrong, who will be responsible?

Does one fix the problem 75% of the way, and hope that the other fixes it 25% of the way?

What if someone can’t live up to their end of the bargain? This can get messy.

To simplify matters, the partners decide to seek out non recourse financing, even if this requires more upfront equity or a higher interest rate.

Non recourse loans are especially attractive to CRE investors looking to do speculative deals.

For another example, let’s say an investor decides to purchase a vacant office building.

The investor plans to improve the property and then lease it up.

Depending on the market, this could be incredibly risky. Let’s say the building is worth $5 million.

The borrower gets a loan for $4 million, resulting in an 80% loan-to-value ratio. Three years later, the property has not leased up as intended.

There is still significant vacancy. The borrower can’t keep up with their loan payments and ends up defaulting on the loan.

Because of the higher than expected vacancy and reduced net operating income, the building’s value goes down to only $3 million, which is less than the outstanding loan balance of $4 million.

In a non recourse situation, the lender does not have any personal recourse to cover the shortfall, so the borrower can simply walk away. The building will be foreclosed upon and liquidated, with the lender eating the loss.

Non Recourse Commercial Lenders

Many commercial lenders will offer non recourse financing to the right borrower (i.e., a quality sponsor with a proven track record, low leverage, on a property in a well-located area, etc.).

Non recourse lenders typically fall into four different buckets: life insurance companies, debt funds, commercial banks, and government-sponsored entities.

Some of the most prominent lenders in each of these buckets are listed below:

Life Insurance Companies:

Debt Funds

Commercial Banks


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