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Recourse that matters

Mortgages are secured against a property. When additional security is required, which is very com...

Mortgages are secured against a property. When additional security is required, which is very common in Canada, a lender will look for recourse to the borrower or an additional guarantor.

The assets held by the corporation or individual will be evaluated for their strength and ability to support the loan.

Recourse to valuable assets gives two reassurances to the lender. Primarily it provides the lender a legal means to recover the full balance of the loan in the event of a default.

The second implied benefit is the existence of financial resources to continue paying the mortgage should the property’s income stream suffer an interruption.

It’s worth mentioning that with non-recourse loans, this aspect is also considered. It is on these two criteria financial statements and net worth statements are evaluated.

Good assets can be accurately valued

Good assets for “borrower strength” purposes are those that can be accurately valued and used to support a financially struggling property. Cash, stocks, bonds, RRSPs and mutual funds are very easy to value and available within days should an emergency arise.

For most commercial borrowers, the most valuable asset is other real estate. Lenders like to see this as we are very comfortable in assessing the relative merits of real estate holdings. Income-producing is prioritized over land, as other mortgages are likely to exist in a portfolio.

The leverage from the other debt is also considered, as low levels can allow room for second mortgages or refinancing if the need arises.

Determining the value of the other real estate is as easy as checking tax assessments, verifying the purchase price of the subject and neighbouring properties, reviewing an old appraisal or completing an income analysis.

Less desirables include cars

The list of assets lenders view as less desirable is considerably longer. Cars frequently have overstated values. Jewelry can be appraised but the resale market will rarely match that figure. Ownership is also difficult to verify.

A non-real estate business is less than ideal. Unless the lender is familiar with the nuances of that industry, accurately assessing the financial statements can be tricky. Items such as goodwill and accounts receivable could be worthless.

Even real estate can fall in this category for a variety of reasons. A mortgaged property that doesn’t generate income in a class-C market is unlikely to provide financial support in the short term and will be lukewarm in the event of remedying a serious default.

Real estate located in other countries is also discounted. While there are legal mechanisms in place to pursue U.S. properties, the process is long and complicated. In most cases, the hassle outweighs the benefit.

The only marginally positive assurance is the borrower can access other equity and cash flow, even though the lender effectively cannot. Countries outside of the U.S. offer even less.

Some merit in spreading out your risk

Some borrowers prefer a real estate portfolio that is composed of five to 15 per cent ownership in numerous properties. There is merit in spreading out your risk, but it weakens the recourse, even though the total value of the real estate may be substantial.

There are now numerous other stakeholders in the property, who could fight refinancing or selling in a moment of crisis that is only being experienced by the minority owner.

Recourse to a real estate portfolio that includes partially developed projects is also carefully considered by lenders. Cost overruns can require large sums of money on relatively short notice. High-interest construction or mezzanine debt can become unmanageable for projects that get off-course. It’s important to remember the borrower also gave recourse to those lenders.

Does this mean you should structure your assets around the ability to offer impressive recourse?

Of course not, but be aware of what your lender really values.

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