What Is Take-Out Commitment?
Take-out commitment is a written guaranty by a lender to provide permanent financing to replace a short term loan at a specified future date if the project has reached a certain stage.
- Take-out commitment is a written guaranty by a lender to provide permanent financing to replace a short term loan at a specified future date if the project has reached a certain stage.
- A take-out commitment is quite common in commercial real estate development.
- Short term lenders usually require a take-out commitment from another lender before they agree to provide the loan.
Understanding Take-Out Commitment
A take-out commitment is quite common in commercial real estate development. It guarantees that a bank will issue a mortgage for the property once the construction or renovation is completed. It also ensures that a long-term commercial mortgage lender will pay off or take out the short-term construction loan and its accumulated interest.
Take-out commitments mitigate risk for lenders of construction loans and allow development to proceed. Property developers typically borrow short-term funds (bridge loans) to pay for construction of their projects.
However, projects can be delayed due to labor strikes, contractor problems, environmental issues or a host of other variables. Faced with the prospect of higher costs from these setbacks, a developer might be tempted to abandon the project and default on the loan. That’s why the short term lenders usually require a take-out commitment from another lender, who has agreed to become the permanent mortgage holder of the finished project, before they agree to provide the loan.
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 such as:
- 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.