Commercial Real Estate Loan Holdbacks and Earnouts

A holdback in a commercial real estate loan is when a commercial lender holds back part of the proceeds of a loan when a commercial real estate loan closes. 

For example, suppose a commercial real estate lender funds a $2 million loan on an office building.  At the time of the closing, one important new tenant was just in the process of moving into the building.  Maybe the lease is signed, but the new tenant is still working on his tenant improvments. 

A loan of $2 million is prudent IF the new tenant actually completes his move-in and starts paying rent, but until then the commercial real estate lender is not comfortable advancing the full $2 million.   Therefore the commercial real estate lender and the borrower might agree that the lender will hold back $400,000 for sixty days until the tenant actually moves in.

The loan documents will actually say $2 million and the borrower might actually be paying interest on the $400,000 being held back.  For this reason, a holdback is intended to be a short-term arrangement.

An earnout on a commercial real estate loan is similar to a holdback, but it is slightly different.  An earnout is a promise by a commercial real estate lender to loan a commercial mortgage borrower more money on his new commercial real estate loan if the borrower successfully increases his scheduled rents. 

For example, a borrower goes to a lender and says, "This apartment building used to be run by an old and sickly owner.  His rents are 30% below market.  Please give me a loan of $2 million today to buy the property and promise me that you will loan me another $400,000 if I raise the rents by 30%."  This agreement is known as an earnout.

In an earnout, the commercial real estate loan is not written at $2.4 million, with the commercial lender merely holding back $400,000.  Instead, there is just a promise from the commercial real estate lender to increase his loan to $2.4 million if, and there is no guarantee that the borrower will be successful, the borrower can raise his rents by 30%.

When the commercial lender does increase his commercial real estate loan by $400,000 - the borrower is typically only charged points on the $400,000 of new money.  If, instead of using an earnout, the commercial lender merely refinanced its old $2 million loan and made a new $2.4 million commercial real estate loan, the borrower would have to pay new points on the entire $2.4 million.  This is the big advantage of an earnout.

You can apply to 750 different commercial real estate lenders in just four minutes using C-Loans.com.