Borrower Type

Definition of Borrower Type

In the context of commercial mortgages, Borrower Type refers to the legal structure and organizational form of the entity or individual that is officially seeking the loan and will hold the title to the commercial property. Unlike residential mortgages, which are typically issued to individuals, commercial mortgages are most often issued to business entities created specifically to own and manage real estate. The borrower type determines the legal obligations, tax implications, and the level of personal liability involved in the debt.

Detailed Description of Common Borrower Types

Lenders categorize borrowers to assess risk, determine the complexity of the underwriting process, and establish the recourse requirements of the loan. Below are the most frequent borrower types found in the commercial mortgage market:

• Limited Liability Companies (LLCs): This is the most prevalent borrower type in commercial real estate. An LLC protects its members from personal liability for the company's debts or legal disputes. Lenders prefer LLCs because they allow for a "Single Purpose Entity" (SPE) structure, which isolates the asset and the loan from the borrower’s other business interests.
• Corporations (C-Corps and S-Corps): While less common than LLCs for individual property holdings, corporations may act as borrowers. These are formal legal entities owned by shareholders. Lenders often require extensive documentation regarding corporate bylaws and board resolutions to approve the mortgage.
• General and Limited Partnerships (GPs and LPs): In these structures, two or more partners own the entity. In a Limited Partnership, the general partner manages the property and holds the most liability, while limited partners act as passive investors with liability limited to their investment amount.
• Real Estate Investment Trusts (REITs): These are large-scale companies that own, operate, or finance income-producing real estate. Borrowing as a REIT involves rigorous underwriting due to the large scale of the portfolios and the specific regulatory requirements these entities must follow.
• Tenants in Common (TIC): This refers to a structure where multiple individuals or entities own fractional interests in a property. While this allows for pooled capital, lenders often view TICs as higher risk because each "tenant" has separate rights, which can complicate foreclosure proceedings.
• Individuals/Sole Proprietors: It is rare for a commercial mortgage to be issued directly to an individual. When it does occur, it is usually for smaller, owner-occupied properties. In this case, the individual has full personal liability for the repayment of the debt.

The Importance of Borrower Type in Underwriting

The borrower type significantly influences the terms and conditions of the commercial mortgage. Lenders look at the legal structure to determine:

• Liability and Recourse: If a borrower is an LLC, the lender may require a "Personal Guarantee" from the principals to ensure the debt is paid, shifting the loan from non-recourse to recourse.
• Ease of Transfer: Some legal structures make it easier to sell "membership interests" in the entity rather than the property itself, which can impact the Due on Sale clauses in the mortgage contract.
• Bankruptcy Remoteness: Lenders prefer borrower types that are "bankruptcy remote," meaning the entity is structured in a way that its insolvency is unlikely to be affected by the bankruptcy of affiliated entities.

Choosing the correct Borrower Type is a critical step for investors, as it balances the need for asset protection and tax efficiency with the requirements of the commercial lender.