Non-Recourse Commercial Mortgages

Many commercial borrowers are asking why lenders are requiring loans with recourse and personal guarantees attached to all commercial mortgages currently.  The answer lies in the 2008 meltdown ofthe financial industry lending markets. Prior to this meltdown, securitization of commercial loans was believed to be a mechanism to mitigate lending risk and provide large pools of capital at lower rates than conventional lending.

In order to increase returns and provide more commercial paper to satisfy the demand, Wall Street lenders begin to lower their requirements by providing non recourse commercial loans.  They naively believed that pooling these loans together would inherently reduce the investors overall risk but still provide higher returns than other investments products that were available.

 Most of these commercial mortgages were then packaged together in large bundles and securitized into CMBS, or Commercial Mortgage backed Securities.  Wall Street followed the same parameters as the residential lending industry by taking hundreds or thousands of commercial loans and packing these together in order to sell to large institutional investors.  This enabled large access to capital for commercial borrowers at lower rates than conventional financing such as community banks or private investors.

Unfortunately, institutional investors became overzealous and naive to the inherent risk of packing all these loans together.  The demand for higher returns and more commercial paper caused the industry to underwrite riskier loans with higher loan to values and less equity than conventional or community banks requirements.  This ultimately became a time bomb than lead to the demise and implosion of commercial securitization loans. Literally overnight in late 2008 when Lehman Brothers became insolvent, the commercial lending evaporated.

Commercial values like residential values begin to fall significantly.  This lead to a downward spiral effect causing many commercial borrower to put up more equity or risk losing their properties to foreclosures.

Because institutional investors began to incur huge multi-billion dollars loss, investors  started to demand more security in the form of higher equity, more collateral and assurances from borrower, hence, most commercial loans began to require recourse with personal guarantees as extra security to protect lender losses. 

Today almost all commercial mortgages will require personal guarantee s and are with recourse against the borrower.  Equity requirements have also increased significantly from 10% up to 30% in many cases.  Additionally, most commercial lending are now through local community banks or  private investors.  All of these lenders want to minimize their inherent risk by requiring higher net worths from borrowers, more liquidty and equity positions and lower loan to values.

It will most likely be several more years before Wall Street type commercial lending will come back.  Until then, all commercial borrowers can expect that new lenders will require personal guarantees and loans with recourse.  Hopefully, we can all learn from this experience.  Common sense should have told us that nothing is free, riskless or goes up in value perpetually.

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