The Guarantee Package
Why the terms that release your guarantees are worth more than the spread you negotiated to get them.
Sponsors run construction loans as rate competitions. Lenders know this, and will often meet you on spread, because they make it back in the guarantee package, which is where the real economics of a construction loan live.
The three guarantees
A completion guarantee obligates the sponsor to finish the project regardless of cost, funding overruns out of pocket. A repayment guarantee obligates the sponsor for some or all of the principal. A carry guarantee covers interest, taxes and insurance during construction and lease-up. They are separately negotiable, and sponsors frequently treat them as a single take-it-or-leave-it block.
Burn-off is where the value is
A repayment guarantee that steps down as the project hits milestones is worth substantially more than a small reduction in spread. Typical structures release portions at certificate of occupancy, at a stated debt service coverage ratio sustained for one or two consecutive quarters, or at a debt yield threshold. The points that matter:
- What triggers each step-down, and whether the test is a point-in-time measurement or a trailing average. Trailing tests are harder to satisfy during lease-up and quietly extend the guarantee.
- Whether the guarantee burns to zero or to a floor. Many term sheets step down to 25% and stop. Whether that floor is negotiable depends heavily on sponsor strength and is frequently never raised.
- Whether re-testing is permitted if the project misses a trigger and later recovers. Without a re-test right, one soft quarter can permanently freeze the guarantee at its current level.
Interest reserve and re-margin
The second place construction loans go wrong. A reserve sized to a base-case lease-up schedule will exhaust if absorption runs slow, and a re-margin provision then requires a cash paydown at precisely the moment the project is least able to fund one. Sizing the reserve to a downside absorption case costs a little more in fee and loan amount, and it is close to the cheapest insurance available in a construction financing.
Key takeaways
- Completion, repayment and carry guarantees are separately negotiable and should be negotiated separately.
- Burn-off triggers, floors and re-test rights are worth more than modest spread concessions.
- Interest reserves should be sized against a downside absorption case, not the base case.
- Takeout certainty determines whether a construction loan is a bridge or a trap.
Capitalizing a development?
Send the budget, schedule and sponsor profile and we will return achievable leverage and a realistic guarantee package.
Start a confidential reviewThis material is for general educational purposes only and does not constitute legal, tax, or financial advice. Terms, programs and requirements change and apply differently to specific transactions; confirm current requirements with qualified counsel and licensed professionals. Gibson Capital Advisors is a debt advisory firm and does not make loans.