We all know that a non-recourse loan is better than a recourse loan – but is recourse as bad as it sounds? In this RV Park Mastery podcast we’re going to explore the real risks of recourse debt as well as concepts to mitigate it and actually embrace it.
Episode 104: Really Undestanding Recourse Transcript
Webster's defines recourse as the legal right to demand compensation or payment. And as an RV Park owner, we don't really like the bank having that ability, so we tend to favor non-recourse over recourse debt. But is the unavailability of non-recourse debt really gonna block you from buying that RV Park? This is Frank Rolfe, the RV Park Mastery Podcast. We're gonna talk all about really understanding recourse debt. Now, let me first say on the front end that obviously all borrowers would prefer non-recourse. Every single one of them. Nobody, if given the option between a non-recourse loan and a recourse loan would ever pick the non-recourse option.
And for those who are unfamiliar with the term non-recourse and recourse, let me define that for a moment. A non-recourse loan means if you were to ever default on your loan, the bank sells the property and cannot recover the amount of the debt, they cannot come after you for the deficiency while completely clean. In a non-recourse loan, the most you can effectively lose is your down payment. But on a recourse loan, if you default on the payment and it goes to the bank and they sell it, and they sell it at a loss, then on a recourse loan, they can come after you to make up whatever money was lost by the bank to make up the deficiencies. So you can lose more than just your down payment on a recourse loan.
Now, that's the key reason why people obviously favor non-recourses. When you have a non-recourse loan, the worst that can happen to you is you lose whatever you put down, but nothing more. And that gives you a really good feeling of comfort, right? You think, well, there's risk inherent in all things in life, but this way my risk is capped. And that would be true. But sometimes you just can't get non-recourse debt. It's not available. Non-recourse debt, typically on RV Parks comes through either seller financing or it comes through conduit financing. But if you're gonna use a bank, typically you're gonna have to sign onto a recourse loan.
So the first thing you have to know about recourse versus non-recourse is if you will not accept recourse, it may greatly reduce your ability to buy an RV Park because you can't always get non-recourse. And then the issue is, if you miss out on those deals, was it really smart? Should we just skip deals that don't have a non-recourse ability? Well, let's drill down for a minute then on what the true risk of recourse is.
Now, when you buy any RV Park, you're gonna have to put some money down, and most lenders are gonna want you to put down 20 to 30%. They're gonna be doing somewhere between a 70 and 80% loan-to-value. Now, what that means is for that property to actually have a loss, if it was taken back by the bank and sold, it would have to decline in value by more than 20 to 30% or whatever amount of your down payment is. Most people, and I would agree with them, would say, now you're crazy if you buy something that you truly believe might decline in value more than 20 to 30%.
So that's the first rule of recourse is how much exposure do you really have? And hopefully the answer is, well, there's no way I can imagine that property going down 20 or 30% in value because I'm buying it with all these great things I can do. I can increase occupancy, I can raise the rents, I can cut the costs. And it's probably true. So you gotta really ponder, can I really lose money on this recourse loan? Is that really possible if that's going to happen? And also, how can you mitigate those risks? What are the risks that you are worried about that could go and hamper your business so badly, it could decline more than 20 or 30%?
If you said, well, I don't know, maybe I'm worried because there might be flooding. Okay, is there a way to mitigate the risk of that flooding? We've had properties where we were able to actually take a property out of floodplain simply by building an earthen berm or some kind of other drainage system. So is there some ways to mitigate whatever the risk is that keeps you up at night? And if the answer is yes, there are, there are ways I can go ahead and minimize my risk, well then that may again give you more comfort in doing the recourse loan because you've quantified how bad things can be.
Another smart idea on any RV Park is to do what's called stress testing. Some lenders already do stress testing. What they'll do is they'll look at the property and they'll say, "Now, what would happen if the revenue declined 10%? What would happen if the expenses went up 10%? How far can we push things before this property gets into real trouble?" Stress testing deals has been around for ages and it's never a bad idea. And once again, if you properly stress test the deal, then you may find that you're not as concerned about the recourse versus the non-recourse aspect.
Also, there are some cases where you can turn a recourse loan in the non-recourse. To get there, typically, you'll have to put even more money down though. Many lenders if you say, "Do you do any non-recourse lending?" They say, "No. No, we don't do that." Well, what if I put 50% down, and then they suddenly say, "Well, yeah, we do non-recourse if you do 50% down." They just never assumed you'd ever offer that. So they just never thought that was on the menu. So in some cases, you could convert a recourse loan to non-recourse if it bothers you a whole lot, you can get there simply by putting more money down. But probably the biggest risk you have with a recourse loan is if you don't buy it because of the recourse loan when you missed out on a good opportunity.
Now, again, this will harken back to the individual deal, the individual market, all the various underwriting and due diligence that any good buyer uses. But some of the best deals you'll find out there, come with recourse debt. You cannot get seller financing, nor is the deal big enough or pretty enough yet to get institutional conduit debt. So it's the deals that fall right in there in between. So you're gonna miss out on a lot of stuff if you will not even consider recourse debt. Probably the better option then is to not be averse to recourse debt, but to be averse to losing money and averse to situations where you're worried that the recourse debt could come into play.
Often when you talk to the bank and you say, "Well, I don't really like recourse." They'll say, "Well, now you shouldn't be borrowing this money if you're really concerned about getting it paid back." That's just a sign you have no confidence in this deal, and that's really pretty much true. So to be a good buyer to really use recourse, you've gotta do excellent due diligence work. You have to stress test that deal, really understand the points of inflection of risk, how to mitigate that risk and that will make recourse even more palatable. This is Frank Rolfe with the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.