Guaranty

A guaranty is a backstop. The borrower on a real estate loan is usually a single-purpose entity that owns nothing but the project, so if the project fails, the lender's recourse is limited to the building. To reduce that risk, lenders require the developer or its principals to sign a guaranty promising to step in with their own resources under defined circumstances.

The most common forms are a completion guaranty, which promises the building will be finished even if costs exceed the budget and contingency; a repayment guaranty, which covers some or all of the loan balance if the project cannot; a carry guaranty, which covers interest, taxes, and insurance until the building is leased; and a bad-acts or non-recourse carve-out guaranty, which applies only if the borrower commits fraud, files for bankruptcy, or otherwise misbehaves. A construction loan almost always carries a completion guaranty; a permanent loan on a stabilized building often carries only the carve-outs.

Guaranties matter for housing because they determine who can develop. A developer must have enough net worth and liquidity to satisfy the lender's guaranty requirements, which limits the field to firms of sufficient size and gives larger developers cheaper access to debt. They also raise the effective cost of a project to the developer, who is putting more than its equity at risk and prices that exposure into the return it requires.