GP or LP providing repayment guarantee?

In development, it appears that in many JV's, the sponsor (who also provided the principal repayment guaranty), can make a capital call to fund the repayment guaranty. If so, why do LP's want the sponsor to provide this guaranty, when they are probably going to be funding 90-95% of it anyways. Why is non-recourse so heavily preferred over partial recourse (20-25%)? If I'm a sponsor, wouldn't I be willing to do 100% recourse knowing that the LP would have to fund most of it anyways if that ever happened. 100% recourse would allow me to secure a stronger financing rate. I think I'm missing something here and wanted to see if someone could help fill the gaps in my understanding.

Comments (5)

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jmkib, what's your opinion? Comment below:

First, generally speaking, many LP's see the GP providing the guarantees (completion, bad boys, and potentially repayment guarantee) as part of the way they earn their promote. Some limited partners will provide their balance sheet for completion guarantees and even repayment guarantees, but this can come at a big cost to the GP (e.g. giving them some of the promote, heavy fees (1-2% of the loan amount or even more with full repayment guarantees), a syndicated piece of the GP entity, etc.) 

Happy to have someone else chime in here and provide some more detail, but in my experience, the LP wouldn't typically want to expose themselves to liability via a repayment guarantee in their operating agreements. You might be thinking of "cost overruns" which can be structured to be split by the LP and GP. But even with cost overruns, many LP's consider keeping the budget to be a responsibility of the GP and therefore want to limit their exposure to cost overruns. There may even be punitive interest rates for capital calls - e.g. if the LP has to fund cost overruns, they will do so at a 15% interest rate

Many LP funds aren't set up to provide guarantees and don't want the contingent liability on their balance sheet. While it would depend on how each operating agreement is set up, I'm struggling to think of scenarios where the LP would willingly structure the situation you are mentioning above into an operating agreement without taking a significant portion of the promote or providing heavy fees in the deal. The GP is effectively passing on the liability of the repayment guaranty to them.

As a side note, many funds may also require warm body guarantors in addition to entities that meet the net worth and liquidity thresholds. 

So the situation you are describing above is, in my experience, not typical. In the hypothetical situation you're describing whereby the LP basically takes on the liability of the repayment guarantee through the operating agreement, the reason why the developer wouldn't want to do that is because they are most likely giving up a sizable amount of the deal through fees and/or promote. Unless they are unable to find non-recourse debt, or the delta between the interest rates is very large, I would imagine that it would be more prudent for the GP to just secure non-recourse debt and pay a higher interest rate. 

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jtd1215, what's your opinion? Comment below:

I second the above as it relates to LPs don't want to carry the liability on their balance sheet. Most LPs are risk adverse and 100% recourse on a development deal is unheard of from my experience. I rather pay a larger spread and take ~20% recourse (even full non-recourse). Something will always come up in a development.. or tenants default and you go into cash management, etc.

  • Investment Analyst in PE - Other

If you work for a developer and getting this unreal deal for you. If you work for an LP and your boss is providing this he probably has a total of two brain cells.

  • Analyst 1 in RE - Comm

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