What is 'Take-Out Commitment'
A take-out commitment is used in commercial real estate development to guarantee a bank will issue a mortgage for the property at completion of the construction or renovation. It ensures that a long-term commercial mortgage lender will pay off or take out the short-term construction loan and its accumulated interest.
BREAKING DOWN 'Take-Out Commitment'
Take-out commitments mitigate risk for lenders of construction loans and allow development to proceed. Property developers typically borrow short-term funds to pay for construction of their projects. But projects can be delayed due to labor strikes, contractor problems, environmental issues or a host of other variables. Facing higher costs from these setbacks a developer might be tempted to abandon the project and default on loan. That’s why construction lenders usually require a take-out commitment from another lender, who has agreed to become the permanent mortgage holder of the finished project.
Working with Take-Out Commitments
A take-out commitment, also called a take-out loan or a take-out agreement, gives the builder the option to borrow a certain amount of money at an agreed-upon interest rate (often pegged to an index) for a certain amount of time. The agreement will include some contingencies. Contingencies may include:
- Design and materials approval
- The completion date of the project
- A minimum occupancy rate before funds are released, perhaps 60 percent
- Provisions for extending the start date of the loan, in the event of delays.
The commitment is often a floor-to-ceiling one. Floor-to-ceiling means there will be a specific final amount loaned for the project, and a smaller amount loaned if the contingencies go unmet. These contingencies attempt to protect or indemnify both the permanent lender and the original short-term lender in the event of problems down the road. The operating principle is that it is the developer’s job, not the bank’s, to make sure the project moves forward smoothly. The bank will endeavor to limit their exposure to the developer’s problems.
Gap Financing for Commitments
Of course, the construction lender does not want to risk that the permanent lender will hold back funds due to contingencies, which could impact repayment of the construction loan. So, take-out commitments also include provisions for gap financing. Gap financing or bridge loans help in case any of the contingencies trigger a partial payment from the permanent lender. For example, if a new office tower has not rented enough units to meet the minimum occupancy clause of the take-out commitment, the gap financing will ensure that the construction lender is paid back even though the final mortgage has not yet been issued.