If Things Fall Apart

If you get a commercial loan for a building that already exists, that building and its income stream can often be the collateral for the loan. If for whatever reason you default on the loan, the lender takes the building and starts receiving the cashflows. This is called “non-recourse” financing. The bank doesn’t need recourse to anyone’s personal assets to feel comfortable making the loan because there’s an income-producing asset behind it. But that doesn’t usually work for construction loans. If something goes wrong with a construction project, there’s no finished building with income to repossess. Performance bonds can help, but at the end of the day, lenders usually want a “personal guarantee.”

My guest in this episode is Jessica Piatt, a veteran of the banking industry who has underwritten hundreds of projects and knows the ins-and-outs of personal guarantees. She is often required to examine the personal and corporate financials of those seeking large construction loans in order to estimate their ability to cover unexpected problems with construction or lease-up. This is a world that many know of but few truly understand. I hope you take as much from the conversation as I did!

After defining personal guarantees (0:16), we discuss whether there are regulatory requirements for them (03:45). I was particularly interested to debate how guarantees affect the culture of real estate development and whether or not there would ever be a reason for lenders to forgo them (06:34). We then discussed outside guarantors (16:50), did a quick sidebar on loan committees (19:17), and returned to the meat of credit underwriting: the main documents requested by banks for guarantor analysis (24:28) and the metrics banks look for (29:04). We wrapped up with a few questions from our viewers (30:52) and a discussion of whether a bank’s requirements for guarantees are affected by the development cycle (39:37).