Recourse or Non-Recourse

13 Replies

I'm currently in a recourse loan on a MF property and in the middle of refinancing. As I evaluate loan offers I am getting both recourse and non-recourse offers. Of course I understand the desire to have a non-recourse loan.  But seems that these inherently come with pre-payment penalty terms, where the recourse loans have no pre-payment penalties.  Is this just how it works or is it negotiable?

For the most part yes, but there are varying degrees of prepayment penalties that can come with the non- recourse loan and some providers will negotiate to a limited extent (not get rid of it altogether but limit it some).

Shop around and see what is out there. Some will have defeasance, some will have yield maint and others may have a waterfall schedule. 

Hey Tony,

I think that's one of the big tradeoffs when it comes to recourse vs. non-recourse. You get to have a little more breathing room knowing that it's a non-recourse loan, but the lender gets some breathing room knowing they have a locked-in yield for an explicit term. That said, I think you'd want to do the math to find out what those penalties actually are and play out a "worst case scenario" from both perspectives. I have not heard of these being "negotiable" although admittedly do not have direct experience.

I spent a few minutes trying to dig up a great BP podcast episode that was with a gentleman that deals almost exclusively with fannie/freddie non-recourse commercial loans, and touches on the penalty issues. Unfortunately I'm having a hard time finding it but someone else in this forum might know it off hand. I believe the long and short of it was that for his particular business it was more advantagous to sometimes have to pay the early pre-payment penalty but I'm sure that's dependent on the overall strategy.

Hope this helps a tiny bit and I'll let you know if I can find the episode :)

Thanks @John Lenhart and @Andrew Fernquist !  I have tried to think through the scenarios and think I am reasonably comfortable that I would not refinance again during the term of the loan.  But selling the property could be more probable and the penalties would definitely need to be factored in to the sales price to avoid eating into our margins.

I guess I am curious if there are MF investors that would opt for a recourse loan to avoid pre-payment penalties.  Or if they just try to negotiate the terms as hard as they can to minimize the impact (but always take the non-recourse financing as a general rule)?

We are more buy and hold investors. Typically, we do traditional bank financing (however many traditional bank commercial loans still have some sort of prepayment) and once we do the value add, we do the non recourse cash out at that time

In my experience, I have never seen non/recourse tied to a prepayment penalty. A personal guarantee, whether full or limited, is a credit enhancement while a prepayment penalty is a pricing and/or yield issue. Like any financing term, they are both individually negotiable but I don't see why one influences the other.

Recourse vs non-recourse is more about the personal guarantee than it is about pre-payment penalties.

For the record, I have both, but I'm in the process of switching most of them out for non-recourse agency debt.

A very important factor to consider (maybe the most important?) is how much risk you're putting your own net-worth in. As investors and entrepreneurs, we naturally see the upside. At the same time, most of us have been around long enough to remember 2008, so we know bad things happen. A non-recourse loan allows you to limit some of your downside while you're playing offense (shooting for above average returns.)

On the other hand, if you have a net-worth that you're willing to put on the line for any particular deal or have sufficient fire-walls in place, then you can be more aggressive.

At this point in the cycle, I would advise caution. Play defense even when you're playing offense.

Hope that helps!

James Kojo

So let me phrase the question in a different manner. How much hassle has a pre-payment penalty been for anyone? If you had a choice (same interest rate) between a 5 year term with a 4-3-2-1-0 waterfall or a 7 year with a 5-4-3-2-1-0, which would you take?

Obviously, different people will have different preferences, or they wouldn't have multiple products! :)

The real question is about your exit strategy. Try to align the term of the loan with the planned exit time of the property (or the next refinance.) Give yourself some room in case there's a downturn and you either can't or don't want to exit.

My personal preference is a 10 year term, and I wouldn't take anything less than 7, for that same reason.

In terms of "hassle", the only hassle is that you're going to have pay a bunch of money if you exit early. However, keep in mind that  agency debt is often "assumable", so you may be able to simply transfer the loan to the next buyer, without paying the pre-payment penalty (although there is going to be some assumption fees for the transfer.)

Another consideration is that if you're going through Fannie Mae, there's something called a "supplemental loan" which can help you, or the next buyer, to re-leverage the property if the equity has increased a significant amount.

Hope that helps!

James Kojo