What Is a Takeout Lender?

The term takeout lender refers to a financial institution that provides long-term mortgage loans for certain types of property. Takeout lenders are normally large financial conglomerates, such as insurance or investment companies rather than traditional banks and mortgage lenders. Takeout lenders often provide financing for large projects. This type of mortgage, which is normally called a takeout loan, replaces interim financing, such as a construction or a bridge loan.

Key Takeaways

  • A takeout lender is a financial institution that provides long-term mortgage loans.
  • Takeout lenders are normally large financial conglomerates, such as insurance or investment companies.
  • Takeout lenders provide takeout loans, which replace short-term financing used to fund the purchase and construction of large buildings like commercial real estate.
  • These lenders offer long-term financing and lower interest rates in exchange for mortgage payments, a portion of rent payments, and capital gains if the property is sold.

How Takeout Lenders Work

Traditional borrowers need to apply and qualify for mortgages before they can get the keys to their homes. But things work a little differently for developers and owners of larger structures such as apartment buildings, multi-family complexes, and other commercial real estate (CRE) properties like medical offices and retail projects.

Most developers start with a piece of land before construction begins. Like other property owners, they usually don't have the money to fund construction costs. These borrowers often get short-term loans that allow them to pay for building costs, including supplies and contractors. These loans come with high-interest rates and short-term repayment obligations. Typically, the borrower must pay the lender a balloon payment, which means the loan comes due in full once construction is complete.

Financial conglomerates such as insurance and investment companies are most often used for takeout loans because these institutions have the necessary capital, staff, and structure in place to allow them to finance such a large loan.

Takeout lenders replace short-term lenders such as banks or savings and loans by providing permanent, long-term loans. These entities usually view the properties for which they provide mortgages as investments. Takeout lenders expect to make a profit on the properties they finance by receiving mortgage payments and interest. These lenders may even be entitled to receive a portion of rent paid to the borrower by their tenants if the property is rented out. They also receive a percentage of the capital gains if and when the property is eventually sold.

Example of Takeout Lending

Takeout lenders allow construction companies to pay off short-term construction loans. Let's say a real estate developer named Acme Development wants to build an apartment complex on a piece of land it purchased in a really great location. The developer takes out a construction loan for $10 million from a bank. This loan allows Acme to buy materials, pay its contractors, and cover any other expenses associated with constructing a new apartment building.

As with most traditional banks, the loan must be paid back when construction is complete. However, because the construction site can’t turn a profit and hasn’t realized its full value, the bank charges 9.5% interest—a high rate—on the loan.

Once construction is finished, Acme Development can go to a takeout lender for a long-term loan with more favorable terms, such as a 30-year mortgage with the building as collateral. The company can get a lower rate of 4% and use the money from the 30-year mortgage to pay off the 18-month loan that financed the construction.

The takeout lender can collect mortgage payments and interest on the loan to Acme, and, if outlined in the contract, may also collect a portion of the rents as well as a percentage of the difference between the property’s sale price and the cost of its construction when the company sells the building.