Essential things to know about a Non-recourse loan
When it comes to real estate investments, many investors usually want to keep the risk exposure minimal to benefit maximally from investment opportunities. But this becomes sometimes challenging when people assume that the collateral security they should put in line is their house.
However, most individuals are unaware that there is a way that you don't need to put personal assets on the front line in running your business or purchasing a commercial property.
A non-recourse loan is one of the ways you can find an acquisition of any commercial property with minimal risks. It is one of the solutions that you will be able to keep your residential property safe when acquiring financing.
What entails a non-recourse commercial loan?
The easiest way to know this kind of a loan is to imagine it as the opposite of a recourse commercial property loan. Therefore, to understand a non-recourse loan better you need to know what a recourse loan is.
In a recourse loan, a borrower needs a personal guarantee to acquire the loan. So that in case of a loan default, the personal assets of the borrower will be put on the line when the bank is unable to get the needed money out of the property.
Now, a non-recourse commercial loan operates in an opposite way. In this case, the bank is limited to the property and the income it generates when it wants to recoup the lost investment.
This means that a bank will only rely on the security of the loan but not go for the other assets of the borrower. In case there is a deficit between the outstanding debt and property’s net realizable value, the borrower will not account for the deficit, but it will be up to the bank to incur that loss.
Why is a non-recourse loan not applicable to all the loans?
In Australia, you will find that only the investments in commercial property allow for a non-recourse loan. However, not all the banks around the country offer this kind of loan and even if they offer not everybody can access it.
Loan values are large
Unlike a standard loan, banks will use a case by case basis to analyse non-recourse finance. A lot of security will be taken by the bank to secure this kind of loan. Since the interest rate charged is high, it is only those loans that exceed 5 to 10 dollars that are available for non-recourse loans.
LVRs are low
The property has to display considerable equity for the lending institutions to qualify borrowers for this kind of loan. Even if some lenders are able to offer a maximum LVR of about 50%, banks like to mitigate risks by offering a lower LVR.
Applicants should be financially strong and experienced
It is the commercial property investors who are established and have a proven track record that banks will give the first preference.
Whenever a bank issues out a non-recourse loan, it is usually confident about the borrower’s ability to manage and maintain an asset. Therefore, this kind of finance type is only accessible to the investors who seem sophisticated.
Possess solid tenants
Apart from having a strong financial position, the applicants should have robust tenants occupying the property. The financial institutions will generally look for a reputable, solid tenant and long-term lease in commercial property.
Therefore it is difficult for individual small investors to acquire these kinds of properties but if they conglomerate to a commercial property syndicate, then getting this kind of financing is easy.
What is the approval process of a non-recourse loan?
In the business loan space, there are quite negotiable interest rates and terms. Therefore, before considering to get a non-recourse loan, you should consider the following:
Is the amount to be borrowed significant?
Due to the enormous amounts of risks, it is only when the value of business or property exceeds $15 million that a borrower will get this kind of loan.
The process
After the borrower is certified to pass the value threshold, lenders will use the following approaches:
First way out
It occurs when a lender considers the debt-service coverage ratio (DSCR) and business cash flow.
DSCR covers the number of times that the borrower’s annual income can cover the interest and principal debt amount.
The DSCR and cash flow is a quite strong indicator for the banks to be confident that they can give the loan even when there is no residential property. Under favourable conditions, a DSCR and interest coverage ratio (ICR) of over 5x is enough to convince most lenders.
Second way out
A borrower can support more the business loan case it has with the bank when there is an intention to purchase a commercial property or use the property housing the business premise as security.
A general security agreement (GSA), which covers all floating and fixed assets will be taken by banks in the second way out procedure.
In this section, only the standard commercial property such as a factory, retail space, and other residential developments are acceptable to most lenders.
Additional security required
In case there is no strong cash flow, the lender can take the business’s inventory value as the security.
The lenders may enforce debt reduction level, of let’s say 10%, to the loan amount after some time period.
Allocation of the directors out of the profits may also be reduced. Through that banks will substantially limit the borrower’s personal income.
Before taking a decision that will financially impact your business, it will be good to seek independent financial advice. Such a move is usually essential for large business loans like the non-recourse loans.
What are the benefits and costs of having a non-recourse loan?
Benefits
- If things go haywire, the bank will not personally hold the borrower but use the commercial property only as the security.
- Although a Director’s guarantee is usually a compulsory requirement if you are a businessman, the bank’s credit manager will waive such a condition for a non-recourse loan.
- Apart from the interest rate requirements, a borrower will get the same terms that are usually allocated for commercial properties like 25, 15, 10 and 5-year terms.
- Even if personal liability is limited, you will still enjoy the leasing tax benefits from a commercial property.
Costs
- It is only the strong applicants who possess strong financials that can access the non-recourse lending.
- Chances are high that you may experience a LVR reduction of up to 50%.
- Investors should be willing to borrow in excess of $5 million to get this kind of lending.
- In comparison with a standard business loan, a non-recourse loan is charged a higher commercial interest rate.