One of the hallmarks of a good investment opportunity is keeping risk exposure to a minimum. In commercial property investment, one of the many ways we reduce risk is by funding the purchase with limited recourse borrowings.
This information is current as at August 2018. For updates on Self-Managed Super Fund (SMSF) information and borrowing under a Limited Recourse Borrowing Arrangement (LRBA), head to the Australian Tax Office’s website. For information on whether an SMSF is right for you, consult your financial advisor or accountant. Do not rely on the information in this blog post; always seek professional advice.
Typically, with a Limited Recourse Borrowing Arrangement (LRBA), the bank has access only to the collateral against the commercial property loan should it need to recover the outstanding debt. The bank has no right to the borrower’s other assets. Their car, home and cash holdings can’t be repossessed or sold to recoup any residual debt.
So, in a worst-case scenario, where a borrower is unable to repay their commercial property debt, the bank’s ability to recover their funding is limited to taking possession of the property securing that loan. If there’s a shortfall between the property’s sale price and the outstanding debt, the bank has to wear the loss – the borrower is typically immune from making up the deficit.
While investors don’t acquire a commercial property expecting it to fail, a limited recourse loan gives the borrower peace of mind by putting a clear limit on their risk exposure.
What’s there to consider with a limited recourse loan?
In Australia, LRBA’s typically only appear in commercial property investment – but not everybody has access to this type of lending. And not all banks offer it.
The banks that do will have their eye on a few factors when considering lending under an LRBA.
Self-Managed Super Funds (SMSF)
First thing’s first, an investor will need a self-managed super fund (SMSF) to access a LRBA in Australia. SMSFs can be an alternative to government regulated super funds and are a ‘do it yourself’ option to saving for retirement. For commercial property investors, there are many things to consider when opening an SMSF (the costs for one) so it’s crucial investors speak to their accountant or professional adviser before they commit.
Large loan values
Far from a standard product, banks will almost always look at limited recourse finance on a case by case basis. Usually limited recourse loans are only available for borrowings in excess of five or even ten million dollars, and they can attract a slightly higher interest rate. Banks will try to take as much security as possible.
Importantly, lending institutions will want to see considerable equity in the property. A maximum Loan to Value Ratio of 50 per cent is not uncommon among some lenders. A lower LVR is the primary method the bank can mitigate their own risk.
Experienced and financially strong applicants
Banks are more likely to consider LRBAs for established commercial property investors with a proven track record. In issuing an LRBA, the bank is effectively “backing” the borrower – recognising their ability to manage the asset and maintain its value. Only sophisticated investors are likely to access this type of finance.
Not only are applicants required to display a strong financial position to be considered for this type of lending – the property’s tenants must be just as robust. Banks prefer property lending where the strength of the tenant is able to be verified (i.e. an ASX listed company). They will look for commercial properties with a long-term lease and a solid, reputable tenant, like Woolworths, Officeworks or Bunnings.
How to take advantage of Limited Recourse Borrowing Arrangements
Not every investor can access an LRBA. They’re also complicated to negotiate, with language, covenants, terms and financial ratios that require specialised expertise.
A smart way to access limited recourse loans for commercial property investment in Australia is to join an established syndicate with strong relationship in the banking industry. But, as always, consult with your financial advisor or accountant before doing so. Every investment comes a risk. It’s your job to be aware of them before making any financial commitment.
The information above is general in nature and should not be considered advice. Before making significant financial decisions you should seek professional advice for suitability.
If you’re interested in investing in high quality commercial property in Australia, get in touch with the team at Properties & Pathways.