The Return of Recourse Loans

These loans were a last resort pre-pandemic, but borrowers are now facing a different set of circumstances, say Malcolm Davies and Zachary Streit of George Smith Partners.

Malcolm Davies

While borrowers typically seek nonrecourse loans, the unusual market conditions created by the pandemic have more real estate developers and owners considering recourse and partial recourse loans. In some situations, a recourse loan makes sense, particularly when a key driver of a transaction is the lowest cost of financing and bank execution is acceptable and attractive.

While recourse and partial recourse loans do carry an additional measure of risk, the benefits may outweigh the risks in certain situations. Sponsors seeking a bridge or construction loan can access very cheap capital through recourse loans right now. For example, we just secured a partial recourse loan at sub 3.0 percent all-in pricing for a ground-up multifamily project in the Mountain States for a client of ours, which is still above pre-COVID coupons previously achieved but still extremely attractive. The financing structure also included a recourse burn-down and burn-off subject to certain DCR and leasing milestones.

Also, as with the above, some capital providers may be comfortable limiting recourse to only a percentage of the loan recourse, especially if the borrower is very strong or if the loan is for institutional sponsors or equity. Having only the top 25 percent of the loan subject to recourse is certainly preferable to 100 percent and further mitigates risk associated with repayment guarantees.

A recourse loan may also be appropriate for projects in challenging markets, like urban cores. downtown Los Angeles, for example, was hit hard by COVID-19, and rental rates at many multifamily properties have compressed. Adding recourse will help ease lender trepidation about a construction project in this area and could help the sponsor secure a rate around 4 percent. Currently, sponsors in less-impacted markets can secure rates at sub 4 percent or less with a recourse loan and the right project.

Zachary Streit

Those best suited to take on recourse loans are sponsors with ample liquidity on their balance sheets that allow for flexibility if the markets are challenging when a sale or refinance needs to occur. No matter how much liquidity is available, however, proceeds and pricing remain important concerns.

Aim for short-term recourse exposure. Construction and bridge loans are the best fit, considering the sponsor will likely be able to sell to remove the liability or refinance to remove contingent liability. Be sensitive to contingent liabilities also and how they can affect your balance sheet and ability to borrow for other projects.

When a sponsor signs recourse debt on construction financing, they will have the opportunity to remove recourse debt by transitioning into a cheap, nonrecourse bridge loan when development risk has abated. When we helped a client make this transition last year, the deal returned equity to the sponsor and actually lowered their interest rate on their multifamily portfolio, even in a pandemic environment. Make sure you understand your exit plan.

We are in an unusual time when recourse loans have their moment in the sun. A year ago, a recourse loan would have been a last resort for many owners and developers. During the first few months of the pandemic, construction loans were mostly unavailable at all.

In this moment, we find ourselves somewhere in between. The recourse loan is a compromise between sponsors wanting to build and lenders needing added sureties. Approached wisely and with the right project, a sponsor can execute a deal, benefit from cheaper rates, and limit the amount of time where they face recourse risk.

Malcolm Davies is a principal/managing director and Zachary Streit is a senior vice president at George Smith Partners’ Davies Group, a capital markets services provider.

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