Wednesday, January 17, 2007

Know About Nonrecourse Loans? How About Carvouts?

In investment real estate, most savvy investors will take out a loan to help purchase a property. This "leverage" (using the bank's money) is just good business. But the many types of loans out there can be confusing. There is one type of loan, if you are fortunate enough to put it in place, is some of the best financing out there.

Called a "Nonrecourse" loan, it is financing set up by the lender based on the strength of the property alone. That said, a nonrecourse loan can be approved if the property is strong enough to stand on its own based on its financials. More succinctly, the numbers make it a very good investment. As a result, in a nonrecourse loan the borrower is not asked to sign personally to guarantee the loan. The implications? Very positive for the borrower/buyer. By not being required to guarantee the loan, if something catastrophic occurs with the property and the loan defaults, the borrower is usually immune from having liens placed against personal assets.

But there are exceptions. And these are called "carveouts." A carveout is an exception to a nonrecourse loan. It results from "bad acts" by the borrower/buyer. It can be related to fraud, or mismanagement that affects the economic viability of the property. For example, a roof is allowed to leak in an apartment or office, and is not repaired in a timely fashion, for example. If this affects tenant retention, the owner could be on the hook personally for the loan, assuming it was a nonrecourse loan to begin with. It basically comes down to the new owner not just sitting back and counting monthly income, but actually ensuring that the property's value is not diminished due to neglect or other mismanagement. There is a great article on nonrecourse loans and carveouts published by financial services giant First American. Check it out at

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