Deciding between 2 potential loans for a Real Estate Investment
If you had to choose between the following two construction loans for a real estate investment, which would you choose and why?
1) 80% Loan-to-Cost construction loan, with 50% recourse, at a floating rate of L+250.
2) 70% Loan-to-Cost construction loan, with no recourse, at a floating rate of L+300.
I assume you may want to know other factors about the investment to make a final decision. In that case, let me know what would be the main factors you would like to account for/what would help determine your decision. Thanks.
I'm risk-averse so I'd opt for #2 if raising capital is not an issue. We've paid much more than a 50 bp premium to get a non-recourse bridge/construction loan recently.
Essentially the question is how hard is it to find that last 10% of equity?
If the project goes south
Option 1) You are "recourse" (for lack of a better term) for 60% of the project costs (80% x 50% + 20%) Option 2) You are only "recourse" for your equity investment, 30%
So if the project goes bad you have to come up with half the cash in option 2 than you would in option 1.
My question is, is this a real scenario? I haven't seen a 70% LTC 0 recourse construction loan for 300+L
Don't really understand the math here. Doesn't "recourse" mean that you can seize assets, that is different than the underlying asset in the original loan, in the event of default?
As far as I understand: In the event of default, you will take the title from the mortgage servicer. You usually try to sell the property to recover your loan (I have seen lender inject their equity to continue the development, but many lender will sell given that they are paid an good amount). Let say that you lend $100 million, with 100% recourse. When the loan is default, you sell the property for $30 million, you can seize borrower's assets to come up with another $70 million.
By the way, I have seen commitment letters with specific amount of recourse more than the percentage. But I guess they are not different.
Your comments are generally correct, I'm not sure where the confusion with the math comes in. Assuming the project is a failure, the developer (and/or their equity partners) is capable of losing the following in each scenario:
1) 20% equity upfront, 50% of the debt on the project: 20% + (50% x 80%) = 60% of total project costs 2) 30% equity upfront, 0% of the debt on the project: 30% + (0% x 70%) = 30% of total project costs
how about zero recourse, zero coupon!
Depends on your liquidity and other investments and contingent liabilities. Unless you were a sick sponsor there is no way we'd issue a zero recourse loan at 70% LTV on a construction loan, and at LIBOR + 300 BPS. Without any other information, I would go with the non-recourse loan.
Without knowing anything beyond what you've provided, I would definitely go non-recourse.
What cost/value do you assign to the 50% recourse?
In your scenario, for the non-recourse loan, you need to bring an additional 10% equity to the deal, and pay an additional 50 bps on your spread. Factor those into your analysis and see how it affects your projected returns vs. the recourse deal. If the increase to your return is enough for you to be willing to take on the additional personal risk the recourse entails, then you have your answer.
A lot of this depends on the property's location. Laws for this are very different by state, but you'll need to understand the difference between recourse, personal guarantees, collecting deficiencies, etc.
The answer will depend on not only the real estate investment itself, but the capital position of the sponsor and its ability to raise equity in the capital markets... If this is for a class you can probably make a compelling argument for either loan being "superior", so long as you note the appropriate pros and cons in the context of the sponsors business needs.
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