Non-recourse loans offer investors the security of not having to repay any of their personal capital should the property they invested in become unsuccessful. The only loss would be the property itself, as that is used as the collateral. This can be a great option for investors who are comfortable with riskier investment plays, as it eliminates the need to worry about being personally on the hook for losses if something goes wrong.

The main advantage of a non-recourse loan for borrowers is the lack of any personal liability. If a loan defaults, the borrower can effectively walk away, after all.

Another advantage of a non-recourse loan is that it can enable an investor to borrow more. This is because the debt isn’t tied to the borrower’s income or total assets — as they aren’t involved in non-recourse financing. With recourse debt, banks and other lenders can place a cap on how much debt they can accept, relative to an investor’s personal income.

Finally, non-recourse loans can be significantly less complicated for a syndication or partnership. Consider the challenges of recourse financing in such a situation: Let’s say three investors pool their resources to finance the acquisition of a shopping center. Which of the three should be willing to put their personal finances on the hook, should the investment go south? Would you do it?

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.

Non-recourse loans are typically available for Class A office or multifamily properties in major MSAs (i.e. New York or Los Angeles). Class B retail properties in tertiary markets are unlikely to qualify. Property income (both past and present) is also a determining factor, as well as the requested amount of leverage.

Sources:

• https://multifamily.loans/non-recourse-commercial-loans
• https://apartment.loans/posts/what-are-non-recourse-loans

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, such as class A office or multifamily properties in major MSAs (i.e. New York or Los Angeles). 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.

Sources:

• What are Non Recourse Loans?
• Non-Recourse Loans

Non-recourse loans differ from recourse loans in that 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.

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:

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.

The tax implications of non-recourse loans depend on the type of loan and the borrower's individual situation. Generally, the interest paid on a non-recourse loan is tax-deductible, just like with a recourse loan. However, the borrower may not be able to deduct the full amount of the interest if the loan is considered a "qualified mortgage" under the Tax Reform Act of 1986. In this case, the borrower may only be able to deduct the interest on the loan up to the fair market value of the property. Additionally, the borrower may be subject to capital gains taxes if the loan is used to purchase an investment property.

For more information on the tax implications of non-recourse loans, please consult a qualified tax professional.