§25.8 - Participating Loans

• Jurisdiction: Washington

§25.8 Participating Loans

Some commercial real estate loans provide for an income participation in favor of the lender, also referred to as "contingent interest" or "additional interest," or provide for a shared appreciation mortgage, also known as an "equity kicker." The borrower's motivation in such a transaction may be to obtain a more favorable rate of ordinary interest than otherwise would be available, to obtain more loan funds than institutional lenders ordinarily are willing to lend, or to obtain financing for a project with a risk profile greater than many institutional lenders would consider. The lender's motivation is to receive an additional return on its loan, over and above ordinary interest. Participating loans primarily are in use outside of the conduit lending industry, whose CMBS bonds are better suited to mortgage income of a predictive nature.

(1) Types of participating loans

In the context of a construction loan for the development of lots or construction of houses or condominium units, a lender's income participation may be expressed as an agreed percentage of the gross sales price of each lot, house, or unit as it is sold by the borrower. Alternatively, the lender's income participation could be calculated as a percentage of the borrower's net profit on each phase of a project, as the lots, houses, or units in each phase are sold, with net profit calculated in relation to the borrower's overall sales proceeds less the "hard and soft" project costs of the phase, such as land acquisition costs, predevelopment expenses, construction costs, sales expenses, and financing costs other than the additional interest. A third variation would be to calculate the lender's income participation as an agreed percentage of the borrower's overall net profit on all phases of the project after it is completely constructed and sold out.

A shared-appreciation mortgage, or equity kicker, entitles the lender to a percentage of the borrower's gross or net gain on a project that the borrower sells as a whole, such as a shopping center, apartment project, or office building, after deducting the borrower's hard and soft costs for its acquisition, construction, or renovation of the project.

In any of these contexts, the loan documents may provide an alternative mechanism of calculating the amount of the income participation owing to the lender if the loan is accelerated or prepaid before the contemplated sale or sales take place. This...