Lending for a JV - limited recourse

[Perp]

OK, I have a feeling I should know this, but I've been having trouble asking my lender the question in a way in which they understand, and I just know that some smart Somersofter is going to know the answer in a jiffy.

Let's say two parties - say two DTs with completely different sets of beneficiaries - want to go halves in a property, and let's say they want to put down a 30% deposit on a $1M property. Each DT contributes $150K cash each, and borrows $350K.

I assume it's possible to get a loan so that each DT is only responsible for its portion, ie if DT2 goes bust and this property is sold at a loss, then DT1's maximum liability is $350K (the amount of its loan), not the $700K that was borrowed in total?

If so, is this a special kind of loan? Do all lenders make these kinds of loan? Is there a terminology for it?

Can the DTs be tenants-in-common of the property (I suspect not), or do they have to each own units in a unit trust which owns the property? Or are there other possibilities for structuring such a deal?

 

[evguenii]

I'm not an expert in financing so the usual disclaimers apply.

what you are describing sounds to me like a typical situation with co-borrowers.

I'll assume that each of your DT has a separate corporate trustee, so for argument sake you have this structure:
Company A trustee for DT A; Director A is a director of Company A
Company B trustee for DT B; Director B is a director of Company B

I'll also assume that you have made a Partnership Agreement where you detail the rights/responsibilities between the partners (i.e. how much each of the partner is putting into the deal and what happens if any of the partners default or want out).

Loan would be as follows:
co-borrowers are Company A and Company B;
personal guarantees by: Director A and Director B
security: Property X owned by DT A and DT B (either as tenants-in-common or joint tenants)

Co-borrowers have what is known as 'joint and several liability' to repay the debt. This means that each borrower is responsible for the entire debt and for making the repayments.
(more info here: http://www.accu.com.au/content.aspx?p=273)

As I understand what you want to do is limit your exposure should things go wrong. So worst case scenario - your partner Director B decides to skip the country and defaults on the loan. You can't pay and the bank sells the property, doesn't recover the full amount and can't find Director B. It will go after Director A (yourself). I'm guessing in turn you will pursue Director B in accordance with your Partnership Agreement.

Another thing each of the partners could do is lodge a Charge Caveat on the Property Title for the amount of money brought into the deal. So if the bank sells the property and has funds leftover it will pay off the charges before dividing the rest.

 

[Perp]

Actually, I'm more thinking that only one entity would take out a loan, and the other entity would be an SMSF. I want to get some leverage into a JV involving an SMSF, but without having to go to a special kind of SMSF loan product.

So, for example, you have a Unit Trust with two units, let's say worth $500K each. The super fund buys its unit with $500K cash. The DT puts down a $100K deposit and wants to borrow 80%, or $400K, to purchase the balance of its unit.

So you end up with a $1M property, with a single $400K loan against it in the name of the DT, and I need to set it up so that the lender has no recourse against the 50% owned by the SMSF. (To comply with SIS Act etc.)

Doable? Or even at such low LVRs is it still necessary to use instalment warrants and bare trusts etc?

 

[evguenii]

I see where you are going with it.

Wouldn't it be easier for the SMSF to simply lend $500k to the DT at the commercial interest rate? The DT will then use the funds as deposit plus borrow another $500k from the bank to purchase the property. The bank will have no recourse against the SMSF as it is not a party to the transaction.

You'll have to check with an accountant/ATO whether this would be an acceptable investment strategy for the SMSF though.

 

[Terryw]

Hi Oz

I have heard it being done in the past, but is very hard to get the bank to agree to it. Not sure what it is called either.

I think it will be hard to set up as if one party were to default the bank would need to repossess the whole property.

 

[boods99]

Gday Ozperp,
we manage several syndicates and basically they are set up as follows;
A Unit Trust is formed with benificiaries being whatever the joint venture members wish them to be. Some are Superannuation funds, individuals, family trusts etc.
The Trustee of the Unit Trust will gain finance for the Unit Trust. That is; Investment Company Pty Ltd atf The Investment Unit Trust.
All benificiaries of the unit trust will need to provide a guarantee, but only to the extent of their percentage shareholding of the Unit Trust.
Should a benificiary be in default of the Joint Venture agreement, there will be provisions within the document as to the correct course of action. Usually, the other members are given the opportunity to buy them out, as well as them losing all rights under the agreement in the interim.
Should the Unit Trust be in default (because of non-performance of one or all unit holders), then the bank will sell the security property and recover costs.

I understand your question in regards to SMSF's, and the requirement for there to be limited recourse, and all of the loan structures I have seen to date do not have the "joint and severally liable" clause included.
I'm unable to comment if this is standard for this kind of setup, or a result of our relationship with the lender, however, I do know that it is possible.

Boods

 

[Perp]

Wouldn't it be easier for the SMSF to simply lend $500k to the DT at the commercial interest rate?

Yes, that would be much, much easier, but unfortunately I'm pretty sure that's against the rules. I think that would be seen as the DT beneficiaries - also the SMSF beneficiaries - receiving a "present benefit" from their super, and that's not kosher.

As an aside, could we do something like... My friend XYZ's super - of which I'm not a beneficiary - makes a loan to my DT at a commercial interest rates? (It may be that my super makes a similar sized loan to XYZ's super at a similar rate. )

I have heard it being done in the past, but is very hard to get the bank to agree to it. Not sure what it is called either.

I think it will be hard to set up as if one party were to default the bank would need to repossess the whole property.

Sure, and I can live with that. I'm trying to convince my lender that if they have no recourse against the SMSF, but still have a personal guarantee for the DT's debt, which is backed by equity in our PPOR (in personal names), then they're adequately protected.

The Trustee of the Unit Trust will gain finance for the Unit Trust. That is; Investment Company Pty Ltd atf The Investment Unit Trust.
All benificiaries of the unit trust will need to provide a guarantee, but only to the extent of their percentage shareholding of the Unit Trust.

See, I want to avoid the SMSF having to give any guarantee at all, since there's no intention for the SMSF to be leveraged. But if the lenders view such an arrangement as a loan to the unit trust, and I can avoid them seeing it as a "superannuation loan" just because some units are owned by an SMSF, then maybe this could work... I'm particularly encouraged by the guarantee being limited to the %age of ownership. Thanks, boods!

 

[HiEquity]

Let's say two parties - say two DTs with completely different sets of beneficiaries - want to go halves in a property, and let's say they want to put down a 30% deposit on a $1M property. Each DT contributes $150K cash each, and borrows $350K.

For me the natural answer is a company vehicle and commercial non-recourse loan.

So DT1 and DT2 (or SMSF or whatever) contribute $150k each into Investment Company (IC) Pty Ltd, which now has $300k cash in the bank.

IC Pty Ltd purchases property X for $1m and gains $700k finance from the bank. This finance will depend on two things...

- LVR covenants are kept whole for the type of security given.
- DSCR (Debt Service Credit Ratio - Serviceability) covenants are kept whole.

With the latter being somewhere over 2x these days, your hope of 70% could be a little optimistic, unless the property is very positively geared.

The Shareholder's Agreement for the company will deal with pre-emptive and step in rights and other obligations but essentially there is no need or expectation for either DT to ever provide more than the original $150k if they don't want to.

If the show turns to pot, the bank will step in and you both lose your $150k. Any further losses are contained within the vehicle, provided you don't give any further guarantees. The need to give those guarantees will be determined by the asset in question, the price paid and the leverage sought.

One can safely assume a non-recourse loan will only be provided at significantly lower leverage to a recourse loan, if at all...

 

[MikeF]

Can the DTs be tenants-in-common of the property (I suspect not), or do they have to each own units in a unit trust which owns the property? Or are there other possibilities for structuring such a deal?

DT's as tenants in common is fine however banks will not provide seperate loans to each DT without the other DT providing a guarantee & mortgage over its share of the property as well.


I've also recently heard that the ATO has concerns with JV structures involving SMSFs where a property is purchased as tenants in common and a lender seeks a cross default agreement (ie, should one trust fail then the other will cooperate with the lender to allow the whole property to be sold.

The issue being the non-defaulting unit holder (SMSF) may suffer detriment if they have been forced to sell the property when property prices are on the increase. Whilst not exactly the same structure with that being considered there are similarities.

See, I want to avoid the SMSF having to give any guarantee at all, since there's no intention for the SMSF to be leveraged. But if the lenders view such an arrangement as a loan to the unit trust, and I can avoid them seeing it as a "superannuation loan" just because some units are owned by an SMSF, then maybe this could work... I'm particularly encouraged by the guarantee being limited to the %age of ownership.

Also, following the ending of the transitional rules from 1 July 2009 involving SMSF investments in related party unit trusts established after Aug 1999, I believe that the regulations now count the SMSF investment as an in-house asset. And whilst the rules allow a superannuation fund with fewer than 5 members to invest in a related unit trust, even after 11 August 1999, it can only be done so long as the unit trust doesn’t do anything that the investing superannuation fund could not do directly itself, such mortgage its property.